HSBC’s allocation securities tied to basket of three ETFs seen as hedge, but term is too long

By Emma Trincal

New York, April 25 – HSBC USA Inc.’s 0% allocation securities due April 26, 2022 linked to a basket of the SPDR S&P 500 exchange-traded fund, the iShares MSCI EAFE ETF and the iShares MSCI Emerging Markets ETF offer an attractive allocation and exposure to global equities, but advisors said the five-year tenor exceeded the timeframe during which they would be comfortable holding the notes.

The best performing of the ETFs will be given a weight of at least 60%, the ETF with the second-best performance will be weighted at most 40%, and the lowest-performing ETF will not count toward the basket performance, according to an FWP filing with the Securities and Exchange Commission. The exact weightings will be set at pricing.

The payout at maturity will be par of $10 plus the basket return. The notes are not principal protected, so investors will receive less than par if that basket return is negative.

Diversification

“It’s kind of an interesting concept. They’re giving you the best of, not the worst of. It’s a refreshing take on it,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

Investors, he added, had exposure to at least two underliers and not just one.

“The nice part is that it’s a diversified portfolio. There’s not a lot of overlap, which is always an issue with diversified portfolios,” he said.

Safety net

Chisholm said he also liked the full upside potential – the notes are not capped. And while the favorable weightings are not a substitute for downside protection, the allocated basket was designed to reduce risk as well as enhance the returns.

The notes could also be used as a hedge against volatility.

He gave the example of emerging markets, the most volatile of the three underliers. Investors worried about price declines could invest into the iShares MSCI emerging markets with more confidence.

“With that basket you eliminate your exposure to the worst ETF and get more than half allocated to the best ETF,” he said.

If the worst-performing fund generates high losses, investors will not be impacted with a 0% allocation.

“If you’re bullish, if you think equities are going to do well, this is a pretty good way to diversify. You don’t have to pick a winner,” he said.

Dividends lost

But Chisholm said the term of the notes made the product a poor prospect for his portfolio.

“I don’t like the lack of dividends. It’s unfortunate because the concept of the notes is good. But you’re not getting paid dividends for five years and that’s a long time,” he said.

The iShares MSCI EAFE ETF pays a 2.85% dividend yield. The SPDR S&P 500 ETF offers a 1.90% yield and the emerging markets fund shows a yield of 1.70%.

Over five years investors are foregoing an average dividend of nearly 11%.

“That’s a lot to give up,” he said.

“The big issue here is the dividends. You also have to look at the credit risk. Five year to me is way too long.”

Tactical play

Jonathan Tiemann, founder of Tiemann Investment Advisors, also liked the allocation mechanism but not the maturity.

“I sort of like it,” he said.

Not knowing in advance the final basket mix may make the strategic allocation slightly more complicated.

“But if you have a general equity allocation, you can be tactical and this wouldn’t be burdensome,” he said.

Finally the choice of the three underlying equity markets – the United States, the developed countries and the emerging markets – offered a broad diversification.

“It’s a really a good exposure. There are reasonable underliers in there, not silly things to own, so it’s got all that going for you,” he said.

No protection

But Tiemann was concerned about the full downside market exposure.

“You could have three losers in your basket and in a bear market the two best ones could still be down a lot,” he said.

In addition, the allocation feature did not “solve” all the “problems” Tiemann said he struggles with each time he tries to decide whether purchasing a structured product or not.

“You’re giving up the dividends, the liquidity, in other words you’ve got all the usual problems.

“On a five year, you sacrifice a lot more especially with the credit,” he said.

“The structure with the weightings still has some appeal. But the five-year term makes me nervous.”

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

The notes will settle on Friday.

The Cusip number is 40435D763.

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