HSBC’s trigger step securities tied to S&P 500 index are designed for sideways market

By Emma Trincal

New York, April 8 – HSBC USA Inc.’s 0% trigger step securities due April 28, 2023 linked to the S&P 500 index offer an attractive payout in a range bound market, sources said. The real question is whether the contingent protection amount will be enough if the U.S. enters a recession within the four-year term, they added.

If the index return is zero or positive, the payout at maturity will be par of $10 plus the greater of the step return and the index return, according to an FWP filing with the Securities and Exchange Commission.

The step return is expected to be 20.5% to 25.5% and will be set at pricing. Investors will receive par if the index declines by 25% or less and will be fully exposed to the index’s decline from its initial level if it declines beyond 25%.

Sources assumed a hypothetical step return of 23% at the midpoint of the range.

Three plus signs

Carl Kunhardt, wealth advisor at Quest Capital Management, was upbeat about the structure.

“I do like that note in this market,” he said.

“Number one, we’ll always have the S&P 500 in the portfolio anyway. There is no way we’re not going to have a large-cap core allocation in the portfolio regardless of what our market outlook is.

“Second, this note is not taking away my upside. You make what the index does above the digital.”

But the real appeal came from the digital payout itself, which is triggered when the S&P 500 index rises only moderately.

“If the index ends up lower than 23%, you get that boost. This return bump up is a corporate bond-like return,” he said.

“You’re automatically reducing the volatility in the portfolio.”

The barrier, which offers a “soft” protection, was also beneficial to investors.

“I’ve got a safety net of 25%. I get exposure to the S&P with some protection.

“If my outlook is range bound, I don’t see any downside to this structure,” he said.

Fair tradeoff

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, also found the note interesting.

“It sounds good for people who think the market is going to be relatively flat,” he said.

“The fact that there is no cap on the upside is really attractive. The barrier is interesting as well because you’re getting this 25% downside protection.”

As always with structured notes, investors are not entitled to the dividends. The S&P 500 yields 1.70%.

“Losing the dividends is not great but you’re getting compensated for that because if the market is flat you get the 23% return, which allows you to outperform.

“If your outlook is neutral to positive, this is a fairly attractive note.”

The barrier in question

The downside protection raised more questions as it was not offered in the form of a buffer (hard protection) but through a barrier. The main question for investors was whether the barrier could be breached at maturity, sources said.

The answer was not clear unless one attempts to predict the market, which none of these advisers ventured doing.

But if investors have a range bound view on the S&P 500 index, the notes would be the appropriate choice, they concluded.

Small odds

“The four-year term could play in your favor but I wouldn’t try to make a long-term call,” said Kunhardt.

“However, we may have a correction because of the recent yield curve inversion. If that’s the case it will happen in the next 12 to 18 months, give or take.

“Whether it will be a 25% correction, who knows? Trying to predict that is a fool’s game. The question is: will you have enough time to recover?

“Four years from now, will the U.S. large-cap market be down 25%? You can never tell, but I think it’s unlikely.

“Sure we could have three good years followed by a bear market. But I think the correction will happen sooner.

“I don’t really see the S&P being down 25% in four years.”

Anyone with a bearish outlook for the period should not invest in the notes anyway.

“This is if you expect a range bound market. If the market trades range bound, you’re getting bond-like returns with bond-like volatility, which is great,” he said.

Notes versus index

The quality of the downside protection depends on the intensity and timing of a market downturn, said Chisholm, who said he expects one.

“We are in a decade-long bull market, so we should have a recession in the next four years. We’re overdue,” he said.

Investors in the notes would have to consider this high probability especially if the recession is painful, which Chisholm said is likely.

“We have been without a recession for a very long time. Ultimately, we need one. If we’re not getting one, it means there’s an imbalance in our macroeconomic and financial system. I believe there’ll be a recession and it will be a harsh one,” he said.

“So, it comes down to how severe the recession will be and whether the Fed can bail us out.”

Yet when comparing the notes with a direct equity investment in the market, noteholders are in an advantageous position.

“At least the notes give you some downside protection,” he said.

For flattish view

The last recession or financial crisis of 2007-08 was short-lived, he noted.

“If the next recession doesn’t quickly rebound like the last one, you may not have enough protection.”

However, the notes offered attractive terms for a non-bearish investor.

“This product does a good job taking care of the upside and sideways part,” he said.

“There’s still a possibility that we may have a sideways market for the next four years depending on what the Fed could or would do.

“If that’s the underlying view, if you think the market will stay within a range, this note can make some reasonable sense.”

UBS Financial Services Inc. and HSBC Securities (USA) LLC are the agents.

The notes are expected to price on April 25.

The Cusip number is 40436B709.

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