HSBC’s buffered uncapped notes linked to low-volatility ETF to target risk-averse investors

By Emma Trincal

New York, June 26 – HSBC USA Inc.’s 0% buffered uncapped market participation securities due July 31, 2018 linked to the PowerShares S&P 500 Low Volatility Portfolio exchange-traded fund are designed for conservative investors who seek to mitigate risk by combining a buffer with some exposure to a low-beta underlying, said Tim Vile, structured products analyst with Future Value Consultants.

The underlying ETF consists of the 100 least-volatile stocks in the S&P 500 index.

If the ETF return is greater than zero, the payout at maturity will be par plus the ETF return, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the ETF falls by 10% or less and will lose 1% for every 1% that the ETF declines beyond 10%.

Conservative play

“Investors looking at this product may seek to hedge a potential correction as the low-volatility index tends to do better in down markets,” Vile said.

“Less volatility means lower price declines. Investors in this note are likely to have a low risk profile. Rather than boosting the upside with leverage, they appear to prefer more safety.”

The buffer is the other feature that fits a more risk-averse profile, he added.

“For a three-year, a 10% buffer with no gearing is quite good. You would need a longer duration or a cap to do the same with the S&P 500,” he said.

The price to pay for this relative level of protection is more moderate returns, which the scoring of the notes will indicate, he said.

Low return score

The return score is Future Value Consultants’ measure of the risk-adjusted return. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. The best among the five market scenarios (bullish in this case) is then used to calculate the return score.

The notes have a 6.40 return score, which is less than an average of 7.51 for similar products, according to Future Value Consultants’ research report on the notes.

“With a low-volatility index, prices are not expected to jump. The lack of any return enhancement does not help either,” he said.

The research firm compares each product’s scores to the average scores for products of the same type. The note fits under the unleveraged return category in Future Value Consultants’ methodology. Each note is also compared to the broader market classified under the all-products type category, which represents recently scored products across all structure types.

The lack of leverage as a contributing factor for the lower return score has no relevance when the product is compared to its peers. However, it makes a difference when the comparison is made to the all-product category, which has a 7.40 average return score, he said.

“The index has shown a good performance with a 12% annual return in average over the past three years, but it has also underperformed the S&P 500,” he said.

“If you extract the 100 least-volatile stocks of the benchmark, you will get an index that will underperform in a bull market. However, people expect a low-volatility index to do well in a down market or during a correction.”

Market and credit risk

The market risk of the product is low, according to the firm’s scores.

The research firm measures risk by adding two risk components, the market riskmap and the credit riskmap. Each score is established on a scale of zero to 10 with 10 representing the maximum amount of risk.

The notes have a market riskmap of 1.05 versus an average score of 2.95 for products of the same type.

“It’s the advantage of a low-volatility index. It reduces market risk. The 10% buffer of course is also a significant factor,” he said.

The credit risk on the other hand is higher than the average for the category at 0.74 versus 0.47, respectively.

“It’s probably not related to the issuer’s creditworthiness,” he said.

The five-year credit default swap spreads for HSBC are 62 basis points, compared with 71 bps for Bank of America, 81 bps for Morgan Stanley and 90 bps for Goldman Sachs, according to Markit.

“It may be because three years is longer than average compared to other delta one products,” he said.

The longer tenor helps the price score, which is higher than average, he noted.

The price score is 6.85 versus an average of 6.61 for similar products.

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

“The longer-than-average term helps spread out the cost over a longer period of time. The 10% buffer, the no-cap are priced quite well. It looks like the issuer did keep the fees at a reasonable level,” he said.

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

“The overall score is low,” he said, commenting on the product’s 6.63 overall score versus an average of 7.06 for its peers.

“The return score drags the overall score down. While the notes are uncapped and while the risk is subdued, the low volatility is not helping on the upside.

“This note may have benefited from some leverage on the upside.

“As it is, the low volatility limits the upside by virtue of the index itself. A cap may not have even hurt the upside that much, and it would certainly helped pay for leverage.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price July 28.

The Cusip number is 40433B2Y3.

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