HSBC’s 2.5-year buffered AMPS tied to Russell 2000 aimed at more risk-averse investors

By Emma Trincal

New York, May 25 – HSBC USA Inc.’s 0% buffered Accelerated Market Participation Securities due Nov. 30, 2020 linked to the Russell 2000 index are designed for investors who expect very low returns and favor downside protection, said Almudena Rojas, structured products analyst at Future Value Consultants. Overall the product is less risky than other short-term leveraged notes as it offers a buffer.

The payout at maturity will be par plus double any index gain, up to a maximum return of at least 20%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

With double the upside and a 20% cap, the maximum annualized compounded return on the notes is 7.55%. This level can be achieved with a very small increase in the underlying index at a rate of 3.9% a year, she observed.

Low expectations

“The risk-adjusted return is an important component when analyzing the profile of potential investors in the note,” she said.

“The buffer feature is more valuable than the gearing and the cap.

“Any aggressive investor would be aiming at a much higher cap. If the index is up around 4% a year you already hit your cap. It’s not an ambitious return expectation. You can easily get the maximum return.

“Investors are probably more sensitive to risk. You have to value the 10% buffer a lot to tolerate such limit on your upside.”

Future Value Consultants produces stress testing reports on structured notes.

There are a maximum of 29 sections or tables for each full stress test report. The firm’s clients can choose any combination of these sections.

Scorecard

Rojas for her analysis of the product focused on one of the sections: the investor scorecard.

This table is made up of a number of different mutually exclusive outcomes of product performance. It shows outcome names, probability of occurrence, average return and average duration. The different outcomes vary by product type and product terms.

For this leverage buffered note with a cap, the outcomes are as follow:

• Maximum return (hitting the cap);

• Positive return (positive return below cap);

• Full capital return (flat or negative return up to 10%); and

• Capital loss (decline in the index beyond 10%).

Easy cap

The Monte Carlo simulation showed a 43.54% probability of maximum return. The positive return outcome will occur only 14.76% of the time.

“Clearly those results show how easy it is to get to the 20% cap level. Getting a positive return below the cap happens less often because it is less likely that the index will be up less than 3.9% per year. Chances are the index will perform better than that,” she said.

“Getting to the cap is by far the most likely scenario.”

Average payoff

Another table illustrated the same point but from the payoff standpoint.

This table named the capital performance tests is divided into two sub-tables. One shows similar statistics as the scorecard but across four other market scenarios – bull, bear, less volatile, more volatile – in addition to the neutral scenario used in the scorecard. This table aggregates cap and positive return, which results in an overall 58.3% chance of making money in the neutral scenario. The second sub-table shows the mean payoff.

This second sub-table indicates that the average payoff in the “return more than capital” outcome is 117.4%.

“This is almost the total amount you would get with the cap. It confirms what we’ve established before. The 120% maximum return is quite achievable,” she said.

Bull and bear

The average payoff for the “return less than capital” scenario is 81.7%, which corresponds to an 18.3% average loss.

Given the 10% buffer, the average suggests a drop in the index of 28.3%.

“It’s quite a substantial decrease and it’s related to the index’ historical performance and volatility,” she said.

The Russell 2000 has an implied volatility of 16.5%, according to the report, which is higher than the S&P 500 index.

Average losses vary with the market environment. In other market scenarios determined by different growth and volatility assumptions, the results vary substantially.

For instance in a bear scenario, probabilities of a positive return fall to 38.44% versus 58.3% in the neutral. On the other hand this probability jumps to 76.67% in the bull scenario.

And while the average loss in the neutral scenario is 18.3%, this figure drops to 14.8% in the bull and rises to 22% in the bear market.

Tradeoff

“You can tell that it’s relatively easy to earn a positive return in a neutral or bull market,” she said.

What the product does best is to protect investors’ principal, she noted.

“Investors focus more on risk control. They agree to limit their potential gains for more protection. That’s the tradeoff,” she said.

The downside protection remains competitive compared to a direct equity investment, she added.

The dividend yield of the Russell 2000 is 1.21%.

“The 10% buffer is large enough to more than offset the non-payment of dividends over the two-and-a-half year investment period.”

Long-only substitute

As a result, the notes can be seen as an adequate alternative to a direct investment in the index fund for risk-averse investors.

“The fund is more flexible. You can go in and out. But the fund doesn’t come with a 10% buffer and a gearing feature that will push up your return and allow you to outperform in a sluggish market,” she said.

“The 120% maximum is mild. But if you don’t expect the market to be very bullish and if you need to mitigate risk, the notes offer an attractive option.”

HSBC Securities (USA) Inc. is the agent.

The Cusip number is 40435FZG5.

The notes will settle on Wednesday.

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