HSBC, Goldman link to emerging funds; sector could draw bullish investors, adviser says

By Kenneth Lim

Boston, May 21 - Products linked to emerging markets could become more popular as investors position themselves for a possible end to the global economic downturn, an investment adviser said.

Issuers have launched a number of emerging market-themed products this week.

HSBC USA Inc. on Thursday unveiled a series of zero-coupon knock-out buffer notes due Nov. 26, 2010 linked to the iShares MSCI Mexico index fund.

If the fund never closes below the knock-out level of 70% of its initial level, investors at maturity will receive par plus the greater of 15% or the fund return. If the notes have been knocked out, investors will receive par plus the fund return.

Earlier, Goldman Sachs Group, Inc. announced a series of zero-coupon leveraged equity index fund-linked notes linked to the iShares MSCI Emerging Markets index fund. The notes will mature after 21 to 24 months.

At maturity, investors will receive par plus 1.5 times any gain in the fund, subject to a maximum total payout of 139% to 146.5% of the principal. The cap will be set at pricing. Investors will receive par if the fund declines by no more than 20%, and will lose 1.25% for every 1% that it declines beyond 20%.

Emerging outperformance

Investors are likely to increase allocations toward emerging sectors if they think that the global economy is about to recover, the adviser said.

"It's the same with small caps versus large caps," the adviser said. "When the economy is doing well, they tend to outperform. The flip side is when the economy slows down, like what we saw last year, they also fall faster."

The greater risk that is associated with emerging markets makes structured products a useful way to gain exposure, the adviser said. Specifically, investors can buy downside protection using a structured product.

"You want something to protect you because this is a relatively risky investment and the value of protection is greater than something that's tied to a less volatile asset," the adviser said. "You have to give up some of the upside to get that protection, but that might be OK if you think you could make 15%, which is a good return."

Investors cannot get that kind of protection on a direct investment, the adviser noted.

Boosting small gains

The HSBC and Goldman products appear to be aimed at moderately optimistic investors, the adviser said.

The accelerated return on the Goldman notes and the contingent minimum return feature in the HSBC notes work best when the underlying assets improve slightly but not by enough to exceed the cap, the adviser said.

The return caps also suggest that buyers do not expect a runaway increase in the underlying assets, the adviser added.

"Usually when you have a cap and the cap isn't very high, they consider that modestly optimistic," the adviser said. "Basically what it means is you think it's going to go up but not by too much."

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