HSBC links six-year CD to 20 stocks; investors go longer amid volatility, distributor says

By Kenneth Lim

Boston, June 29 - Structured investors have been more open to longer-dated products, but maturities have not gone beyond six years, a distributor said.

HSBC Bank USA, NA launched a series of structured certificates of deposit at that upper limit.

HSBS plans to price principal-protected contingent annual income CDs due July 31, 2015 linked to an equally weighted basket of 20 common stocks.

The basket comprises the stocks of Amazon.com, Inc., Lowe's Cos., Inc., Philip Morris International Inc., Wal-Mart Stores, Inc., Chevron Corp., Schlumberger Ltd., Bank of New York Mellon Corp., JPMorgan Chase & Co., Gilead Sciences, Inc., Johnson & Johnson, Lockheed Martin Corp., Union Pacific Corp., Apple Inc., Oracle Corp. Freeport-McMoRan Copper & Gold, Inc., Monsanto Corp., AT&T Inc., Verizon Communications Inc., Entergy Corp. and FPL Group, Inc.

Interest is payable annually and will equal the sum of the weighted returns of the basket stocks. The coupon payment each year will be subject to a floor of zero, and each stock's return will be capped at 10% to 15%. The exact cap will be set at pricing.

The payout at maturity will be par.

Short-term risks

The market turmoil in 2008 kicked short-term volatility for many underlying assets up to extremely high levels, the distributor said. That discouraged investors from investing in short-term investments because the amount of uncertainty was too high.

"I think between November and March the S&P 500 could lose 15% one week and make back 15% the next week easily," the distributor said. "Nobody had any clue what anything was going to be three or six months out. But investors were a little more comfortable about making predictions that were three to five years out."

The financial crisis also pushed investors toward safer products that protect their principal, which also helped to push back maturities.

"The cost of offering 100% principal protection goes down the longer the product because long term volatility is lower than short-term volatility," the distributor said. "So the banks had to attach longer maturities to their principal-protected products in order to keep them attractive."

Six-year limit

But structured products in the United States have generally not gone beyond six years, the distributor said, and even those are rare.

Part of the reason could be culture, given the U.S. investor's preference for shorter-term trading ideas, the distributor said.

"I think our market is still very driven by trading ideas and strategies, which is why the [three-month to one-year] reverse convertibles were so popular," the distributor said. "I think in Europe and in Asia where structured products are also quite popular, they're seen more as savings types of investments that can last for 10 to 15 years. Kind of buy-and-forget type of investments."

But longer-term investments also carry risks for investors, the distributor added.

"Most of the time the investor is locked in for however long the product takes to mature," the distributor said. "There are parties that will buy a structured product from you before maturity, but it's not a very transparent or liquid market and because of the structures some products don't really gain any significant value until they mature."

Trying to make market predictions too far into the future can also be difficult for investors.

"10 years ago some of the companies like Lehman Brothers or General Motors or United Airlines would have been reasonable stocks that you would put in an income basket, for example," the distributor said. "Guess what? Ten years later those are very different businesses...I think five to six years is kind of the comfortable limit for many investors here in the U.S."

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