HSBC’s leveraged notes tied to MSCI EAFE offer defensive play on developed markets

By Emma Trincal

New York, Sept. 14 – HSBC USA Inc.’s 0% buffered accelerated market participation securities due Sept. 20, 2019 linked to the iShares MSCI EAFE exchange-traded fund are designed for conservative investors.

But whether the cap level is sufficient or not will depend on how bullish investors are on developed markets.

The payout at maturity will be par plus 150% of any fund gain, subject to a maximum return of 14.25%, according to an FWP filing with the Securities and Exchange Commission. Investors will receive par if the fund declines by 15% or less and will lose 1% for each 1% decline beyond 15%.

Steve Doucette, financial adviser at Proctor Financial, said he liked the buffer on the downside but not so much the 14.25% cap level on the upside, saying that potential gains would be too limited.

“If you’re OK with that, if you’re not hugely bullish for the next two years then I guess it makes sense,” he said.

“I see it more as a bearish play because it’s really on the downside that you’re more likely to outperform.”

Single-digit gains

When investing in equities, Doucette said he does not want to limit the upside to single-digit returns.

“If I look at equity returns, we’re trying not to cap ourselves less than 10% a year. A 7.5% return isn’t bad but if the index continues to run you’re giving up a lot of the upside,” he said.

“You benchmark yourself and I guess it all comes down to: is 7.5% enough for still taking most of the downside risk?

“You need to ask yourself: Do I want to be buffered or have room to grow?”

Restructuring

The answer to these questions is not easy.

But Doucette said he would be willing to make some adjustments to the notes in order to maintain the buffer at its current level while increasing the upside.

“I am not going to give up anything on the buffer. But I could reduce the leverage so I can get the cap up.”

Alternatively, he would be willing to add another layer of risk to achieve the same objective.

“You may want to introduce another index and get the worst-of.”

Either way, the risk-adjusted return would have to be tilted in favor of a more aggressive investment.

Balancing act

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, said the risk-adjusted return of the notes was well balanced.

“We like it. It’s a short-term note and we’re at a point where we’re fairly late in the market cycle for equities,” he said.

As a result investors need to be more cautious than before.

“This is for conservative investors who are beginning to think about upside versus downside risk,” he said.

“If you consider the balance of risk and the fact that valuations are a little bit on the high side, having an accelerated return of 1.5 times with a real buffer could be a very attractive package considering that balance of risk, particularly with this kind of multiple...depending on investors’ objectives of course.”

Relative value

Pietsch is relatively bullish on developed markets. The underlying ETF had a “great year” so far but he said that he believes “there’s still quite a bit of room on the upside.”

The iShares MSCI EAFE fund is up more than 17% for the year to date.

The “risk” is on the upside. But for cautious investors, the cap is the tradeoff for a protection against the downside, he said.

“I wouldn’t be uncomfortable about that cap. You have to think of the probabilities of extraordinary gains for the next two years.

“Developed markets have been doing well, and we don’t expect a major correction. But even though these markets may have more upside on a relative value versus the U.S. we don’t expect extraordinary returns.

“It’s all about probabilities.

“On balance we think this is an attractive package for a conservative to moderate investor weighing the upside versus the downside risk.”

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40435FGC5) will price on Friday and settle on Sept. 20.

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