HSBC AMPS linked to emerging markets ETF offer leveraged upside, similar-to-better downside

By Kenneth Lim

Boston, Sept. 3 - A couple of accelerated notes linked to an emerging markets index fund offer investors a way to outperform small gains in the underlying, said Future Value Consultants analyst Suzi Hampson.

"I think these two products are going to appeal to similar types of investors," she said. "They have very similar structures, the same underlying."

HSBC USA Inc. plans to price two series of Accelerated Market Participation Securities linked to the iShares FTSE/Xinhua China 25 index fund, which tracks 25 of the largest and most liquid Chinese companies trading on the Hong Kong Stock Exchange.

The first note is a 13-month zero-coupon security. At maturity, the note will return triple any gain in the fund up to a return of 24% to 29% of the principal. Investors will lose 1% for every 1% decline in the underlying.

The second note is a 15-month zero-coupon security. At maturity, the note will pay double any gain in the fund up to a return of 15.5% to 20.5% of the principal. Investors receive par if the underlying ends flat or declines by less than 10%. Investors lose 1% for every 1% decline in the fund beyond 10%.

Indirect alternative

Both products will probably appeal to investors who are ready to invest directly in the underlying fund because the risk exposure is not very different, Hampson said.

Investors give up the potential to participate in any increase in the fund above the cap in exchange for greater participation in smaller increases.

"It's a growth product," she said. "So it's still capital at risk. The risk profile isn't so different from investing in the fund. The difference is on the upside, where you get the gearing. For investors who don't expect large growth over the next year, the gearing might be more appealing."

The shorter-term note, in particular, is much more similar to the underlying fund. That product is equivalent to an initial portfolio that has a 75.93% allocation to the fund, a 14.07% allocation to bonds and a 9.99% allocation to cash, according to a research note by Future Value Consultants.

In terms of volatility, the 13-month product's annualized volatility of 21.71% is not too far off from the fund's 30.41% volatility.

Different risks

But while Future Value Consultants scored both products with similar overall ratings of just above 8 out of a best possible 10, the shorter note earned a significantly riskier rating than the longer product.

The 13-month note's "riskmap" score was 6.53 out of a riskiest possible 10, which reflects the likelihood of varying levels of principal loss and the product's volatility. The 15-month product's riskmap score was 3.77.

"Our riskmap score looks at the downside of the product and the probability of losing certain ranges of downside, so the inclusion of the buffer [in the 15-month notes] makes it less likely you'll lose capital," Hampson said.

At first glance, the 10% buffer may not seem like much when the underlying volatility is 30.41%, but that protection goes a long way, Hampson explained.

For example, if the index fund declines by 20%, for the 15-month note you lose 10%, whereas for the 13-month note you lose 20%, "which is quite a bit of a difference," she said.

Investors who are already invested in the underlying fund may be more open to investing in the shorter-dated, higher-geared notes "because you'll do better than the fund and the downside risk is the same," Hampson said.

But more conservative investors will probably prefer the longer product.

"The advantage of the 1.25-year product is it does have the buffer, and it's still offering a return of 115% to 120%, which on an annualized basis is still well above risk-free rates," Hampson said.

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