HSBC’s PLUS due 2017 tied to Russell 2000 index show value to investors, analyst says

By Emma Trincal

New York, Sept. 18 – HSBC USA Inc.’s 0% Performance Leveraged Upside Securities due Jan. 5, 2017 linked to the Russell 2000 index bring value to investors with an attractive upside, said Tim Vile, structured products analyst at Future Value Consultants, based on his firm’s scores.

The research firm rates structured notes based on several scores, including price score for value and return score as a measure of the risk-adjusted return. Risk is also rated based on two components – market and credit.

The payout at maturity will be par of $10 plus triple any gain in the index, up to a maximum payment of $11.73 per note, according to a 424B3 filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

Vile pointed to the main benefit of the product: its 300% participation rate.

“With a very small growth of the index, you’re getting almost 14% a year as a maximum return,” he said.

If the Russell 2000 index was to rise by 4.60% a year, investors would get the capped return, which on a compounded basis is 13.62% a year.

Cap a factor in view

“It’s quite a strong gain per year. The flip side is that you’re not getting any downside protection. Because of that, the investor certainly has to have a bullish outlook,” he said.

“But people who would buy this product are not overly bullish. Their growth expectations are limited. If you get capped out when the index gain is less than 5% a year, you’re not very bullish. At the same time, by virtue of the three-time leverage, you can make substantial gains and nicely outperform the index.”

Vile noted that the 13.62% annualized cap could be achieved over a short duration.

“The odds of reaching the cap are pretty good if the index rises, even by not much. However, investors need a high tolerance for risk since they have full exposure to the downside,” he said.

“The 15-month term could end up being a bit risky if the market suddenly dropped because you may not have enough time to see a rebound.”

He noted on the chart that the Russell 2000 index and the S&P 500 were correlated.

“But choosing the slightly more volatile index may help with some of the terms, such as the cap level,” he said.

The Russell 2000 index has an implied volatility of 19.27% while the S&P 500 index shows one at 17.55%.

Riskmap

Future Value Consultants measures the risk, or “riskmap,” by adding two risk components – the market riskmap and the credit riskmap. Each score is established on a scale of zero to 10 with 10 representing the maximum amount of risk.

The notes have a 3.32 market riskmap versus an average of 3.28 for the average leveraged return note, according to the report produced by Future Value Consultants.

“The market risk is about average when compared with other leveraged return notes. It may mean that we see fewer buffers and barriers in this market or simply that the Russell is not a stock and doesn’t show a huge difference in volatility compared with most of the indexes that are used in these products, including the S&P,” he said.

The credit riskmap is 0.45 compared to 0.56 for the average of the same product type, the report showed.

“The credit riskmap is slightly lower. This is due to two main factors: it’s not a very long-term note and HSBC is a strong issuer,” he said.

Return score

Future Value Consultants measures the risk-adjusted return of each product with its return score.

The score is calculated using five key market assumptions – neutral, bullish, bearish, high volatility and low volatility. The best of the five scenarios is selected to measure the risk-adjusted return on a scale of zero to 10.

With this product, the optimal scenario is bullish.

At 7.28 the return score is lower than the 7.86 average for the leveraged return category.

“It’s a bit disappointing and we know it’s due to the cap because the riskmap is pretty average so the risk is not the main factor. It’s on the return side that we have to identify the main factor. But those scores are relative by nature. We may be comparing the notes with a sample of uncapped products or products with higher caps.

“To put things in perspective, the score is still high at more than 7. So it’s certainly not a poor product,” he said.

Price score

For each product, Future Value computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 7.48 price score while the average for the product type is 6.16.

“The price score is very good. It suggests that the issuer spent a good deal of money in buying the options. A lot of value is offered to investors,” he said.

“You have three times upside participation, which is a lot. The issuer had to buy the calls to put together this structure. In addition, being able to get 14% a year is a strong return. Many times, return score and price score go hand in hand but not here. With this structure the cap eats the return score but not the price score.

“It shows that value to the investor and risk-adjusted return are two different things.”

Overall

“This distinction is helpful because the high price score leads us to an above average overall score. Despite a disappointing return score, this product ends up being very strong.”

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score is 7.43 versus an average of 7.01 for similar products.

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

The notes will price on Sept. 30 and settle on Oct. 5.

The Cusip number is 40434K834.

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