HSBC links five-year product to financials; attractive mix of long maturity, depressed sector, adviser says

By Kenneth Lim

Boston, Dec. 22 - HSBC USA Inc.'s planned performance securities linked to the financial sector is unusual for its underlying asset and its long maturity, an investment adviser said.

HSBC, through agent UBS Financial Services Inc., plans to price zero-coupon performance securities due Dec. 31, 2013 linked to the Financial Select Sector SPDR fund.

At maturity, if the underlying index ends above its initial value, investors will receive par plus 108% to 111% of the index gain. If the index finishes between 50% of its initial level and its initial level, investors will receive par. If the index declines by more than 50%, investors will lose 1% for every 1% decline in the index.

The exact participation rate will be set at pricing.

Unusual underlying, maturity

The Financial Select Sector SPDR fund has not been a common underlying asset for structured products in the past few months because of uncertainty about the health of financial stocks, the investment adviser said.

"Financials were still quite popular at the start of the year, but for the past few months nobody's been willing to touch them," the adviser said. "The sector was too volatile. Nobody knew how the stocks were going to do one day from another. It could be up 20% today, up 20% tomorrow. Nothing that gave you enough protection was attractive enough."

But the sector could be seeing renewed interest.

"I think the number of people who think the sector could be reaching a bottom is increasing," the adviser said. "Some of the stocks are at 10-year lows. They don't have that much more room to go."

Long-dated structured products are also in the minority these days, the adviser added.

"In an uncertain market, investors are often more comfortable with shorter products because making predictions farther out becomes more difficult," the adviser said. "Comparing a six-month to a one-year product, I only have to figure out what's going to happen six months from now versus one year from now. If I'm right, I have the option of reinvesting in six months. If I'm wrong, I cut my losses earlier and I can reassess the markets to decide my next move."

Combination works

But the combination of both features - the underlying and the long maturity - could work for the product, the adviser said.

"If you think that financials are bottoming, this could be an attractive product," the adviser said. "The long maturity actually works here because a lot of the uncertainty now is very short-term. So I could think the sector is near a bottom, but I don't know if it will go lower next week or the week after. But I'm fairly confident that within five year it would have started to recover."

The barrier, leveraged returns and the lack of a return cap also help the product's appeal.

"There's a slight leverage on the upside and there's no cap, so you don't have to worry about the fund going up too much," the adviser said. "And the downside protection is also quite good if you think about it. For a six-month product, 50% might not be a lot, but in a five-year product, 50% is much more attractive."

Risk of underperformance

But the adviser said investors still need to consider whether financials will offer a good return in the next five years.

"I guess one concern would be whether financials are the best sector to invest in at the moment," the adviser said. "I assume the investor is looking for a way to peg his or her returns to a market sector that he or she thinks will outperform the general market and risk-free rates for the next five years. So the question is will the financial sector outperform the general market and risk-free rates for the next five years?"

"The other concern is that this isn't principal protected, so there's still a chance that the fund could end up below 50%, and if that happens you immediately lose at least 50% of your principal, so that's a risk you need to consider," the adviser added.

© 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.