HSBC ties accelerated notes to financials; timely for bullish view but risky, adviser says

By Kenneth Lim

Boston, April 20 - HSBC USA Inc.'s planned accelerated notes linked to the financial sector is a risky product despite a low barrier, an investment adviser said.

"It's low, but that's because the underlying is volatile enough to actually be able to hit it," the adviser said.

HSBC plans to price zero-coupon enhanced market participation notes due June 14, 2010 linked to the Financial Select Sector SPDR fund.

At maturity, investors will receive par plus double any gain in the underlying fund, subject to a maximum total payout of 150% of the principal. If the fund ends between its initial level and 60% of its initial level, investors will receive par. Investors will lose 1% for every 1% decline in the fund if it finishes below 60% of its initial level.

Volatile sector

The financial sector has been in the spotlight recently because of new optimism about the health of U.S. banks, the adviser noted.

"There's been a bit of an increase in optimism about financials. Investors looked at some of the bank earnings and some of the economic data and probably enough people liked what they see to give the markets a bit of a rally," the adviser said. "I guess this is probably quite timely, hoping to ride on some of this optimism."

The HSBC product would perform best if the underlying fund moves up moderately, the adviser said.

"It's quite a common kind of recovery structure," the adviser said. "You give up principal protection, take some risk on your capital, which the investor is probably more comfortable doing if they think the underlying's going to go up, and they get the accelerated upside, which lets them take part more of the recovery.

"You still have a 40% barrier on the downside that allows you to still get your principal back if the underlying doesn't go down by too much. But there's a cap at 50%, so there's no participation above that amount, so the investor probably doesn't think it's going to go up by that much, otherwise buying the fund directly would be more profitable."

Still risky

The 40% barrier on the downside may look generous, but it could be highly risky for investors, the adviser said.

"I think, even without understanding the intricacies of structured products and options, an investor can generally assume that whatever barrier or buffer you get in a product, there's always a reasonable chance that it could be breached," the adviser said.

"That's how the issuers can hedge it and price it and offer it to the market. The only issue for the investor is, based on the trading strategy that I want to take at this time, is this a good investment to make? If you're already thinking of buying the underlying fund directly, then you might want to look at this and say, maybe I'm willing to give up any gains above 50%, but I get double the participation from 0% to 25% and principal protection from 0% to -40%. If you're not sure where the fund is going to be heading in 13 months, maybe you want something a little more conservative."

Any loss on the product will also be severe, the adviser added.

"It's kind of like a cliff on the downside," the adviser said. "It's not like you slowly lose capital if the fund goes down. Once you lose capital, it's at least a 40% loss straightaway. That's going to be very painful for anyone."

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