HSBC’s buffered AMPS tied to MSCI EM ETF come too soon despite correction, contrarian says

By Emma Trincal

New York, Sept. 7 – As emerging market continue to tumble, buying opportunities emerge for structured notes investors willing to bet on a recovery and eager to buy at a relative bargain. As a result, some issuers have announced and priced notes linked to this asset class in an effort to attract the contrarian bid.

But is it the right time? One such contrarian, always on the lookout for “unloved” asset classes, said it’s too soon as there is more room for emerging markets stocks to slide.

HSBC deals

Case in point: HSBC USA Inc.’s 0% buffered Accelerated Market Participation Securities due March 29, 2021 linked to the iShares MSCI Emerging Markets ETF. The notes will pay double any fund gain, up to a maximum return of at least 27.25%, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

Separately, HSBC is planning the same note but on a two-year term and a slightly lower cap of 25%.

“I prefer the two-and-a-half year one. The longer the period, the better,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

“With two-and-a-half years you have a little bit of an opportunity to catch an eventual rebound although you’re still likely to come across a worldwide recession by then.”

Too soon

In pure valuation terms, a bet on this asset class comes either too soon or too late, according to this portfolio manager.

“What’s good about the emerging markets right now is that they’re much less overvalued than the U.S.,” he said.

“We’re heading toward a bear market in the U.S., which will precipitate the economy into a recession. For some reason U.S. markets haven’t dropped yet. Perhaps the emerging market sell-off was an overreaction to negative headlines. Or maybe it reflected an early slowdown coming up.”

For Kaplan, getting exposure to emerging markets now remains premature.

“It’s not the ideal time to get into emerging markets. Two-and-a-half years is better than two years. But if you’re bullish, you want to invest over five or six years. You need enough time to catch the next cycle.”

Too late

An ideal entry point would have been January 2016, when the ETF share price fell to its lowest level since the financial crisis, he said.

Looking back, it’s easy to find what would have been the best investment timeframe for a note pricing at that point.

“You may not know how long to hold the position. But you can certainly have an idea of when it’s a good window to get in,” he said.

“From a value standpoint, January 2016 was a unique opportunity to buy.”

The best exit point would have been the recent January peak.

Investors fortunate enough to buy a note in January 2016 and see it mature two years later would have been rewarded by an 85% positive return assuming a delta-one payout.

“The Emerging Markets ETF has dropped significantly since January. But valuations in January 2016 were much, much lower,” he said. “So that’s why it may not be low enough yet.”

“We think there is more room for further price decline even though China and India are not doing so bad.”

Harder times looming

The timing is essential because emerging markets do offer some value at the moment. Yet the asset class is vulnerable to the risk of a global recession.

“A recession in the U.S. will of course have a ripple effect on the rest of the world, including emerging markets. So, I would wait,” he said.

“The next two years are not going to be good in general. If we start to see a pullback later this year in the U.S., I may revise my timing and reconsider emerging markets as a buying opportunity. But I would want to see prices drop much more.”

Fair value for safety

Emerging markets are pricing “closer to their fair value” at the moment, he said.

The asset class was “undervalued” in January 2016 and “overvalued” last January.

“We’re moving in the right direction. Emerging markets are less overpriced than they have been before and they’re much less overpriced than the U.S. market,” he said.

For Kaplan the risk is mostly based on macroeconomic assumptions, as he sees an end to the U.S. bull market soon due to excessively rich valuations near bubble levels. A bear market will then lead to a global economic downturn, he predicted.

He explained why he is a contrarian.

“I keep an eye on emerging markets because it is somewhat unpopular. As I mentioned before it’s all about timing the next recession,” he said.

“In general, I like unpopular securities because people are not pricing it up to very high levels where you have the risk of a drop.

“A lot of emerging markets have already dropped 20% since January.”

Precious metals anyone?

Kaplan said he is curious to see structured notes tied to the types of assets that are on his radar for purchases.

“I’m looking for notes on gold miners or on silver,” he said.

Structured notes linked to silver have not been seen this year. The exception was Credit Suisse AG, London Branch’s $561,000 contingent coupon deal linked to the iShares Silver Trust ETF, but it was a worst-of also linked to the SPDR Gold Trust ETF, according to data compiled by Prospect News.

“It’s strange. When an asset is really compelling, like emerging markets in early 2016, you won’t find a lot of notes. People are interested in popular, overpriced securities so that’s where issuers come in I guess,” he said.

Regarding Kaplan’s interest for gold miners, supply was also very thin this year.

There were only 11 offerings linked to the VanEck Vectors Gold Miners ETF, the dominant equity fund for this industry that price this year for a total of $15.5 million, according to Prospect News data.

Kaplan said he is likes this underlying, just like he liked emerging markets in January 2016. The share price of the VanEck Vectors Gold Miners ETF is down more than 40% from its five-year high of August 2016.

Bonds on bonds

Back to emerging markets, Kaplan said his preference would go to sovereign debt rather than stocks.

“Prices are very depressed for the debt of those countries. You get much better bargains than on the stocks,” he said.

When told that structured notes tied to bond funds were rare with the exception perhaps of the iShares iBoxx High Yield Corporate Bond ETF and in very rare cases Treasury bond funds, he expressed surprise.

“Really? I wonder why,” he said.

Not a structural issue

Looking at the structure of the notes, Kaplan said the upside was acceptable.

“I prefer a product without a cap. But at least this one is not too bad. Just short of 11% a year. That’s not a bad rate of return.

He liked the buffer but was skeptical.

“Having a 10% buffer helps although if we have a recession, it probably won’t be enough,” he said.

“A lot will depend on the timeframe. This is why I’d rather sit and wait before allocating funds to this investment.

Other deals

HSBC is not the only issuer showing emerging markets-linked notes.

Barclays Bank plc plans to price three-year leveraged buffered notes tied to the iShares MSCI Emerging Markets fund. The notes are set to price on Sept. 25.

Credit Suisse AG, London Branch and GS Finance Corp. has also announced issues linked to this ETF alone.

At the end of last month, BofA Finance LLC priced $14.95 million of two-year leveraged capped and buffered notes on this underlying as well.

Bank of Montreal and Toronto-Dominion Bank have also priced smaller deals recently.

The HSBC notes will price on Sept. 25 and settle on Sept. 28.

The Cusip number is 40435F2L0.

The other HSBC offering with a two-year tenor and a 25% cap will price on Sept. 28 and settle on Oct. 3.

Its Cusip number is 40435F2G1.

HSBC Securities (USA) Inc. is the agent for both deals.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.