HSBC’s lookback allocator notes tied to three European indexes seen as best-of yet risky play

By Emma Trincal

New York, April 23 – HSBC USA Inc.’s 0% lookback allocator notes linked to three indexes offer a “best-of” structure that allocates more to the best-performing indexes. Yet the lack of downside protection and the choice of the three underlying country-specific benchmarks are notable risk factors, advisers said.

The indexes are the Deutsche Borse AG German Stock Price index, which is a capitalization-weighted index of 30 German stocks traded on the FWB; the CAC 40 index, which is a capitalization-weighted index of the 40 most significant French stocks among the 100 largest market caps listed on Euronext Paris SA, and the IBEX 35 index, which is a price return index composed of the 35 most liquid securities listed on the Stock Exchange Interconnection System of the four Spanish Stock Exchanges, according to a 424B2 filing with the Securities and Exchange Commission.

Three countries

“I’m not sure I would be looking at these countries if I invested in Europe. I’m not much of a fan of France and Spain,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

Another adviser agreed.

“We know Germany is the one that is doing half-way decently. The others aren’t,” said Steve Doucette, financial adviser at Proctor Financial.

“That’s why I buy an international manager to get broad exposure. I would have to do some due diligence to choose the best countries.”

Asset allocation tool

The tenor is expected to be three and a half to four years and will be set at pricing, according to the prospectus.

The payout at maturity will be par plus 60% of the return of the best-performing index, 30% of the return of the second best-performing index and 10% of the return of the worst-performing index. The notes are not principal protected, so the payout could be less than par.

“It’s a neat product if you’re an asset allocator. It gives you a little bit of an opportunity to outperform because you get the heavier weighting to the best-performing index,” Doucette said.

“I do like the concept. It’s a best-of, a way of capturing some outperformance by virtue of the weightings.”

No protection

For Medeiros though, the “allocator” feature, which allocates more to the best performers, is not a substitute for a barrier or a buffer.

“I’m not particularly a fan of this structure. I don’t like the fact that there’s no downside protection,” he said.

“Just because the best index carries a heavier weighting does not mean you have protection. What if they’re all negative?

“I can achieve this type of outlook more efficiently by just utilizing ETFs and allocating them dynamically.

“If you invest in a structured note, you’ve got to have a benefit, and to me, the downside protection is a must.

“When you have to pay for the fees, give up the liquidity and assume the credit risk something needs to be offered to compensate you for that.

“Giving you a different type of allocation is not going to cut it. That’s something I can do on my own.

“You can do it at a cheaper cost and with plenty of liquidity without taking on the credit risk of the issuer when you use ETFs.

“I’d much rather have the flexibility of using ETFs and rebalance the components the way I want.”

Due diligence

Doucette said that while the structure is attractive because of the “allocator,” the choice of the underlying benchmarks is less compelling.

“I would pick other indexes. The components of my note would probably be regions, not countries,” he said.

He suggested as an example the Euro Stoxx 50 index, the MSCI EAFE index and “some” Asian index.

The MSCI EAFE index tracks the performance of developed countries outside of North America. It has an exposure to European markets of at least 60%, including the United Kingdom. The Euro Stoxx 50 is the benchmark for the euro zone.

“This would give you a broader exposure, although there might be some overlap between the Euro Stoxx and the EAFE,” he said.

Last month, HSBC priced $4 million of 0% lookback allocator notes due Sept. 18, 2019 linked to the S&P 500 index, the Euro Stoxx 50 index and the Hang Seng China Enterprises index, according to a 424B2 filing with the SEC. The allocation percentage rates for the final payout were the same.

“That’s how you get broad exposure. This is Asia, Europe and America. Much more diversified,” he said.

“I just wouldn’t take country bets.

“I would stick to a note in international equity and I would decide if I want to mix emerging markets and developed countries. Usually I don’t. I like to keep them separate.

“I would also have to do some research on the correlation. I don’t know if it’s best to pick indexes that are highly correlated or not. If they’re not correlated, you really outperform with the best one. At the same time, the others could be down a lot, dragging down your return. It’s hard to tell. I would have to run an analysis, consider the what-ifs and look at the weightings.

“This is not a note you can buy without doing a serious amount of due diligence. You have to figure how you might model your best expected return.”

HSBC Securities (USA) Inc. is the agent.

The notes will price in April and settle in May.

The Cusip number is 40433BU97.

© 2015 Prospect News.
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