HSBC's AMPS tied to iShares MSCI Mexico Capped give country-specific emerging markets exposure

By Emma Trincal

New York, Jan. 29 - HSBC USA Inc.'s 0% buffered Accelerated Market Participation Securities due February 2016 linked to the iShares MSCI Mexico Capped exchange-traded fund give investors who are bullish on emerging markets a rare opportunity to make a single-country bet, sources said.

The payout at maturity will be par plus double any gain in the fund, up to a maximum return at least 19%. The exact cap will be set at pricing, 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 each 1% that it declines beyond 10%.

Deals giving exposure solely to the Mexican equity market have been limited to 14 offerings in the past five years, according to data compiled by Prospect News.

The iShares MSCI Mexico Capped ETF seeks to reproduce the performance of the MSCI Mexico IMI 25/50 index.

Winners and losers

"If you believe that emerging markets should rebound and do well, then Mexico should be well positioned," said Ferenc Sanderson, partner at PrevInvest, a research and pension advisory.

"Within the emerging markets bucket, you have a number of countries that have suffered far more than others, usually due to current account issues, political issues and currency issues. Today, I don't believe that Mexico has current account issues, and its currency is very tied to the U.S. A number of reforms should lift demand, so overall Mexico should do well compared to other emerging countries."

Fed-induced turbulence

Taking a bullish view on Mexico and emerging markets was a "big theme" a couple of weeks ago when institutions thought that it was time to reallocate away from the United States into emerging markets, he noted.

"But with the Fed cutting down $10 billion a month its bond buying program, all bets are off," he said.

With the Fed reducing its monetary stimulus, global markets have recently seen an outflow of capital from emerging markets countries as investors anticipate rising interest rates in the United States and a retreat from riskier assets.

The anticipation of further cuts in the Fed's monthly bond-buying program spurred an emerging market sell-off last week.

The MSCI Emerging Markets index, which is the broad benchmark, has lost 9.50% so far this year. Since Tuesday last week, it has dropped 6%. The Mexico ETF has declined by nearly 8% so far this year.

The Fed announced Wednesday that it will cut its monthly bond purchases by an additional $10 billion to $65 billion starting next month.

The S&P 500 fell 1% on that day, and the MSCI Emerging Market index dropped by nearly 1.50%, recording a 3.65% loss since Jan. 22.

For investors who remain optimistic on the potential growth in emerging markets with Mexico seen as one of the potential winners, the notes offer an attractive structure, said Michael Davis, partner at Varick Asset Management.

"This product fits a bullish view on this particular emerging market country. It gives you an attractive upside performance, and you're getting protection," Davis said.

"The key to the cap is that you're not paying for the upside performance that you don't think is reasonable. If you buy the ETF and lever your position, there is the possibility that the ETF will go from where it is now to two times that. With this product, you're taking this possibility off the table. You are not participating in the unlimited two-times but only from zero to 19%, right in the middle of the bell curve where you see the highest potential for gains.

"At the same time, you're taking off some of the tail risk. That kind of protected structure with some amount of leverage to a cap is very popular."

The choice of 19% as a cap was a function of option pricing, he said.

"You are buying at-the-money calls and selling out-of-the money calls," he said. "Buying the calls at the money is going to be more expensive. Your call spreads are two-times notional. The cost of all that will depend on a variety of factors, including the volatility skew curve. You'll have to finance that by selling some volatility somewhere. For instance, the short put position designed to create the buffer will also give you some additional revenue to finance the calls. You also finance part of that with the fixed-income component, although this is not giving you that much in the current interest rate environment."

A bit more volatile

The additional volatility coming from the use of a single-country index versus a broad index may have been another factor behind the deal, a market participant said.

"The Mexico index is not widely used. I think picking up a little bit of extra volatility was probably a factor," he said, adding that the 100-days historical volatility of the Mexico ETF is 22%, compared with 19.8% for the broad MSCI Emerging Markets index.

"It's a little bit more volatile, and it's perhaps because of that that you can give somewhat better terms to this structure.

"This deal was not necessarily designed for investors with a country-specific view on Mexico. It could simply be a non-diversified way to gain access to emerging markets with better terms because you can capture some additional volatility, although not a lot."

Another factor was the market itself, he said.

"Firms are looking to differentiate themselves from the competition. The MSCI Emerging Markets index has been done so many times. Some issuers are trying to use some variations on the same theme. They pick the emerging markets story but from another angle and see if it works," he said

"You start with the broader market and then you try to give people a chance for a more specialized exposure."

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40432XS85) will price and settle in February.

The MSCI Mexico IMI 25/50 index is designed to measure broad-based equity market performance in Mexico. A capping methodology is applied that limits the weight of any single component to a maximum of 25% of the index.

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