HSBC’s jump notes linked to WisdomTree Japan Hedged ETF remove currency risk, boost return

By Emma Trincal

New York, Feb. 23 – HSBC USA Inc.’s 0% jump securities due Aug. 29, 2016 linked to the WisdomTree Japan Hedged Equity fund offer a boost on the upside over a short period while removing exposure to exchange rate risk.

If the final share price is greater than the initial share price, the payout at maturity will be par of $10 plus 11%, according to an FWP filing with the Securities and Exchange Commission.

If the final share price is equal to the initial share price, the payout will be par. If the final share price is less than the initial share price, investors will have one-to-one exposure to the decline.

Equity focus

For Donald McCoy, financial adviser with Planners Financial Services, using the WisdomTree Japan Hedged Equity ETF as the underlying simplifies exposure to Japanese equity markets for U.S. investors.

One of the fund’s characteristics is to provide a hedge against fluctuations of the dollar versus the yen.

When buying an unhedged version of a foreign equity fund, U.S. investors benefit from the weakening of the dollar against the foreign currency but make less money when the dollar strengthens.

“When you’re investing in Japan without the currency hedge, you’re kind of rolling the dice about where the currency is going,” he said.

“With this note, you get a pure equity play on Japan. The currency exposure is hedged away. It’s not necessarily a good or a bad thing. It just removes some of the complexity.”

In some cases, an equity fund that hedges currency risk may underperform a similar equity fund with no hedge, he said.

“This note is not going to help you benefit from the rise of the yen against the dollar, which we’re seeing right now,” he said.

He compared the performance of the WisdomTree Japan Hedged Equity ETF with an unhedged investment, the iShares MSCI Japan ETF.

The notes’ underlying fund has underperformed the iShares MSCI Japan ETF by seven percentage points. Respectively, they are up 10.7% and 17.7% this year.

“The dollar has really dropped against the yen. If you’re hedged, you’re missing out on this,” said McCoy.

But the point of buying a currency hedge – the feature, he noted, is not cheap –is not to make bets on the currency.

“These things flip all the time. Over six months, you can’t predict if the yen will still be strong or not. What people want is to be able to focus on equity and only on that,” he said.

Discount

Japanese stocks have disappointed investors who were hoping that the Japanese central bank’s efforts to ease would lift share prices.

It has not happened. Over the past year, the fund has hit bear market territory, down nearly 23%.

“If you can get 11% in six months or 22% a year, that’s a pretty good return,” he said.

“All you have to do is be a little bit up. Whether you’re getting a boost or getting capped, that rate of return is still pretty decent. And you don’t have to wait long to figure out if you’re right or wrong.”

For aggressive investors expecting a recovery in Japanese stocks, the notes allow investors to quickly outperform the market. But the notes are not to be offered to everyone.

“I certainly wouldn’t look at putting conservative investors in this due to the lack of downside protection,” he said.

“Japan is a major trading partner of China. If you’re concerned about the Chinese economy, you have to stay away from the one-to-one downside, obviously.

“But if you want exposure to Japanese stocks, if you consider that we’re coming off a bad quarter for Japan and that things may rebound, this is a good opportunity to get in at a discount.”

Short term, value

Jonathan Tiemann, president of Tiemann Investment Advisors, LLC, said he sees value in the notes for bulls.

“Removing currency risk exposure makes sense. The yen surprised everybody by taking off, so the hedged version of the fund works against you right now,” he said.

“But I think if you are interested in investing in Japan, this is not a bad instrument.”

The duration of the notes is attractive in his view.

“My main thing with structured notes is always the lack of liquidity and the exposure to credit risk. Six months, I can live with,” he said.

While the notes have no downside protection, the return enhancement offered via the digital payout is very attractive, he noted, especially over the short duration.

“It’s interesting how they were able to offer this jump on a six-month. I would think it has to do with HSBC’s funding levels,” he said.

“I actually like this note. I’m shocked. I usually tend to be pretty picky with structured products.

“If the index is up more than 11% you would be better off with the ETF, but 11% for six months is nothing to be unhappy about. On the downside it’s like being long the fund.

“If you want to make a short-term bet on Japan, this is a note that can deliver some pretty attractive upside.”

HSBC Securities (USA) Inc. is the agent with Morgan Stanley Wealth Management handling distribution.

The notes (Cusip: 40434N689) will price on Wednesday and settle Feb. 29.

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