HSBC’s leveraged buffered uncapped notes tied to S&P 500 aimed at cautiously bullish investors

By Emma Trincal

New York, Aug. 18 – HSBC USA Inc.’s 0% leveraged buffered uncapped market participation securities due Aug. 25, 2022 linked to the S&P 500 index offer equity exposure with less risk, which is consistent with a bullish outlook as the upside return is unlimited, said Suzi Hampson, structured products analyst at Future Value Consultants.

The tradeoff for investors is a five-year holding period without receiving dividends.

The payout at maturity will be par plus at least 1.05 times any index gain, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 25% and will lose 1% for each 1% decline beyond 25%.

Tradeoff

“The buffer is the selling point in these notes. It’s quite a decent amount,” she said.

“Any falling in the price of the index up to 25% and you get that protection and beyond that, your losses are cushioned,” Hampson said.

“You will outperform on the downside.

“In exchange for that you’re not going to get the total return of the index, which you would get if you invested directly in the index.”

“But if you want equity exposure with less risk, this is a reasonable option.”

The 25% has a cost, she noted, which is why the issuer had to lower the leverage factor. An alternative would have been capping the upside, which was not the solution adopted in this structure.

“If the market does very well, the uncapped upside gives you the potential for high returns,” she added.

Stress tests

Future Value Consultants produces stress test reports on structured notes. Each full report consists of 29 sections, allowing the firm’s clients to choose any combination they find useful.

Hampson illustrated some of her observations using two of the tables included in the stress test report produced for these notes.

At first she analyzed the scorecard, a table that provides probabilities for a number of different mutually exclusive outcomes of product performance. The model generates the scorecard based on a “neutral assumption,” or “base-case” assumption for each outcome.

Scorecard

“This type of product is pretty simple compared to others like the phoenix autocallables for example. Here you only have three outcomes,” she said.

The model describes them as “positive return”; “full capital return” (when the index declines by less than 25%); and capital loss.

Consistent with market pricing the neutral scenario reflects a very conservative growth rate assumption, she explained. In this report, it is only 0.1% per annum.

The scorecard shows a 54.37% probability of a positive return.

“You get a positive return more than half of the time, which isn’t bad considering the low-growth assumption that we have here. Basically that’s what you get when he market is flat,” she said.

For its scorecard simulation, Future Value Consultants uses a Monte Carlo model. Other reports however display backtesting tables for three specific time horizons, which are the past five, 10 and 15 years.

Backtesting

“If you compare the 54% probability with the backtesting on the last five years, it’s quite a different story,” she said, referring to a 92.52% probability over that time period.

“You can’t say it’s going to repeat itself. But investors like the concept of knowing what the index did before. If you go back 15 years, the chances of making money drop drastically to 53.43%. It’s similar to the neutral scenario. We know that the last 15 years have covered rocky years.”

The product in general shows modest probabilities of loss of capital. While there is a 21.62% chance to see the index drop beyond the buffer level in the neutral assumption, the backtesting show much more limited results.

Over the past five years, there was a 0% chance of capital loss. It happened only 2.4% of the time over the last 10 years and 1.62% of the time in the past 15 years.

“It’s pretty clear when looking at the backtesting that the chances of losing money are very low. This is essentially due to the strong bull market we’ve had since the beginning of 2009,” she said.

“And while investors should not expect future returns to reflect past performance it looks like the 25% buffer provides a solid downside protection contributing to these results as well.

“Some investors may prefer more leverage and less protection, and those would be more aggressively bullish investors. But the note is not designed for that. It’s for investors who consider the buffer to be important enough.”

Market assumptions

The model also produces tests based on four other market scenarios in addition to the neutral assumption. Each scenario is constructed from different growth rates, she explained.

The capital performance test table shows the same outcomes described in the scorecard with the simulations assigned to each of the four other market scenarios. Those are: bull, bear, more volatile and less volatile.

The probability of gains is obviously the highest in the bull market scenario, at 80% versus 54.37% in the base case, according to the capital performance table.

“It’s not surprising but the gap between bull and the other scenarios is huge,” she said.

“With these participation products it’s very easy to tell what scenario is best.”

The difference in probabilities between on the one hand neutral and on the other, the two volatile assumptions – more volatile and less volatile – was minimal. Chances of getting a positive return in a more volatile market were 52.57%, and 56.28% for the less volatile.

In the bear scenario, this probability dropped to 25.84%.

Suited for bulls

The bullish case is even stronger when one considers the conservative growth rate used by the model for this scenario at 5.3% per annum. The index decline assumption for the bear market however is also conservative at minus 5.2% a year.

“The conclusion we can draw from these tests is that in a bull market the product will perform well,” she said.

“You can get exposure to the S&P by considerably reducing your potential for capital loss.

“Of course very risk-adverse investors can always opt for full capital protection. But their return is going to be lower.

“With this you’re taking a little bit of risk but not as much as if you bought the index itself.

“This is not suitable for everybody. But it may appeal to those investors who are a bit cautious but still want to invest in equity.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on Aug. 18 and settle on Aug. 25.

The Cusip number is 40435FCR6.

© 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.