HSBC ties best-of notes to S&P; timely feature gives high return over wide range, adviser says

By Kenneth Lim

Boston, May 11 - HSBC USA Inc.'s planned best-of notes linked to the S&P 500 index is a recovery product that arrives just as the underlying has experienced a recent rally, an investment adviser said.

HSBC plans to price zero-coupon best-of performance notes due May 28, 2014 linked to the S&P 500.

If the index never closes below a trigger level of 50% to 55% of its initial value, the payout at maturity will be par plus the higher of 35% or the index return. The exact trigger level will be set at pricing.

If the trigger has been activated, the payout at maturity will be par plus any gain in the index. If the index is flat or lower by no more than 10%, investors will receive par. Investors will lose 1% for every 1% that the index falls by more than 10% if the trigger has been activated.

Timely strategy

The HSBC product allows investors to take part in any increases in the S&P 500, the investment adviser said.

If the trigger level is not activated, investors will outperform the underlying index until it gains more than 35% - a productive range from between 50% and 55% to 135% of the initial level. That wide range makes the product a useful investment if the underlying's decline is slowing.

"If you think the S&P 500 is near the bottom, this could be a good product," the adviser said. "The most important thing is the S&P 500 cannot fall by more than 45% to 50%, otherwise you don't get to enjoy that best-of part of the notes. You lose principal in the worst case, or just get a delta-one kind of return in the best case [if the trigger is activated]."

A strategy that rewards investors if the S&P 500 does not fall by too much could draw more interest now because the index has seen a strong rally in the past few weeks, the adviser said.

"There's certainly a lot of discussion now about whether we're reaching the bottom, and I'm sure there are quite a number of investors who are optimistic going forward," the adviser said.

The best-of feature also works better in a recovering market, because the market tends to come out of a downturn slower than it fell, the adviser explained. Investors are therefore more likely to enjoy an outperformance if the index recovers slowly and does not go up by more than 35%.

Risky alternative

Despite the 45% to 50% trigger, the product is still relatively risky because investors only have a 10% buffer if the notes are triggered, the adviser said.

"Once it's triggered, you're already 45% to 50% down, depending on where the barrier ends up, so it's going to be quite unlikely that you'll go back up," the adviser said. "But on the other hand, they don't stop you from getting back some return if it goes back up, so that's a positive.

The same rally that makes the notes interesting also adds to the risk, the adviser said.

"If what we've seen is just a bear rally, this means we haven't reached the bottom and if you buy you'll be buying a high," the adviser said.

Investors who want a safer product might look for notes that provide better downside protection in the form of more generous buffers and barriers or even principal protection, the adviser said. Investors who are more confident about the market and want better participation in the upside can look for simple accelerated growth notes that, because they do not have to pay the investor as much if the index declines, will probably offer more on the upside.

"You have to pick the one that fits your strategy and portfolio," the adviser said.

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