HSBC’s barrier AMPS linked to S&P Europe 350 Low Volatility may help navigate rocky markets

By Emma Trincal

New York, Sept. 1 – HSBC USA Inc.’s 0% barrier Accelerated Market Participation Securities due March 2019 linked to the S&P Europe 350 Low Volatility index may be timely for euro bulls as volatility increases worldwide, buysiders said.

If the index return is positive, the payout at maturity will be par plus 150% of the index return, subject to a maximum return that is expected to be at least 42% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 20% or less and will be fully exposed to the decline from the initial level if it declines by more than 20%.

New

“I don’t think I’ve seen this underlying before,” said Tom Balcom, founder of 1650 Wealth Management.

“In this environment, with the surge in volatility that we’ve had in the past 10 days, people are interested in low-volatility strategies. Apparently this index is designed to do that.”

The S&P Europe 350 Low Volatility index measures the performance of the 100 least volatile stocks in the S&P Europe 350 index.

This is only the second deal to price based on this index, according to data compiled by Prospect News, which tracks U.S.-registered structured notes. The first offering, also issued by HSBC, consisted of $714,000 of five-year leveraged buffered uncapped notes. It priced at the end of May.

“We have such indexes for the U.S. I’m not aware of any in Europe,” continued Balcom.

“HSBC should be commended for bringing something like this to the market because a lot of people are wanting exposure to Europe and a lot of people are interested in low-volatility strategies.”

Smart beta

The S&P Europe 350 Low Volatility index was launched in July 2012.

The index gained 12.28% last year. Its five-year annualized return is 14.88%, according to back-tested performance available on Standard & Poor’s website.

From 2005 to 2014, during the course of 10 years, the index underperformed the S&P Europe 350 index only in the years 2005, 2007 and 2009, according to the website.

“The performance is better, and you can reduce volatility. It’s definitely appealing,” said Balcom.

“Anytime you have a note that allows you to do two things – here it’s investing in Europe with a low vol focus – it’s always beneficial to investors.”

U.K. overweight

Investors should always look at the index constituents, said Balcom, noticing that the biggest country in the index is the United Kingdom with a 43% weighting.

“I’m not saying it’s bad necessarily, but this is not a substitute for the Euro Stoxx 50. It’s not a benchmark for the euro zone.

“But for investors looking for European equity exposure with low volatility, it’s a good option.”

The prospectus in the risk section pointed to currency exposure as the assets will be bought in foreign currencies and then converted into dollars to calculate the index level.

If the dollar strengthens against the European currencies, the level of the index will be “adversely affected” and the return “may be reduced,” warned the prospectus.

Currency risk

“The notes hedge the volatility but not the currency exposure. You can’t get everything in one instrument,” said Balcom.

“But it’s something you have to add to the equation. Obviously if the index performance is good, it’s not something that will erode your entire profit. But it’s a risk.”

He noted that many among his investors dislike having exposure to exchange rates in general.

“People don’t tend to have a view on currencies. Which way the euro versus the dollar will go in three years? I have no idea. Most of my clients have no idea either. I’ve never had a client making a currency bet.”

But in general, Balcom said he found the notes relatively attractive.

“If someone wants European exposure and is worried about volatility, this might be a good trade for them,” he said.

Euro bulls

Donald McCoy, financial adviser at Planners Financial Services, said that the underlying strategy may offer an edge to investors bullish on Europe.

“I know some international funds or ETFs that strive to have a low-volatility strategy, but to my knowledge they’re more individual strategies than indices, and I don’t know of something specifically euro-centric using the low-volatility approach,” said McCoy.

“It seems like a pretty healthy strategy. Europe seems undervalued, but there are no guarantees that the market will recognize its value, so it’s not bad to have a 20% barrier for three and a half years.”

The first decision for an investor is whether or not to invest in European stocks.

“From a global perspective, outside of the U.S., Europe in my opinion will be the place to be. But that’s now,” he noted.

Low-volatility strategies have grown more popular as investors seek to stabilize the returns of their portfolios in times of market uncertainty and price declines. Sectors picked for those strategies are usually more defensive.

While low-volatility portfolios tend to outperform in down or bear markets, they are not immune to losses, he said.

In 2008, the S&P Europe 350 Low Volatility index declined by 31.15% while the S&P Europe 350 index dropped 42.20%, according to the Standard & Poor’s website.

“There is no way you can preserve your capital only by using a low-volatility strategy, but to get three-quarters of the decline is an excellent achievement,” he said.

He stressed the importance of analyzing the components of the index.

Defensive

“One thing you have to be careful of is sector allocation,” he said.

“When you want to reduce volatility, you may find that you own a lot of stocks in a limited number of sectors.

“For instance, I may have a dividend fund or a utilities fund, and if the index allocates a lot to utilities, I may end up being overexposed to utilities.

“In this case, I would watch the top sectors and make sure there isn’t too much overlap with the rest of my portfolio.”

The largest allocation goes to financials with a 26.3% weighting, followed by industrials with a 19.1% weighting, according to Standard & Poor’s. In contrast, health care, telecommunications and IT have much smaller weightings of 4.7%, 4% and 2%, respectively.

The benchmark is rebalanced quarterly.

“In this index, you’ll miss a lot of the growth stocks, so you have to be prepared. If the market rallies, you should know why you’re underperforming the market. If technology and health care drive the rally, you’ll be left behind.”

Dollar bulls beware

McCoy also looked at the currency exposure as a risk to which dollar bulls should pay particular attention.

“The currency risk can be an issue. If you expect the dollar to appreciate against the euro, then it’s going to be a bit of a headwind that this index has to fight against. It could inhibit performance,” he said.

“This note would be even better if it could hedge currency risk. Of course there are two sides of each trade. If the dollar weakens in three and a half years, then it’s a good thing for the noteholder.

“But with the Fed beginning its tightening cycle and Europe easing, things seem to suggest that we’re heading toward a stronger dollar. If the dollar appreciates at the end of the term, it could come right out of your bottom line.

“Other than that, I think it’s a pretty decent note in this turbulent market environment.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price and settle this month.

The estimated initial value of the notes on the pricing date is expected to be between $920 and $970 per $1,000 principal amount.

The Cusip number is 40433B7L6.

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