HSBC's averaging notes tied to Dow Jones Industrial Average an alternative to cash, bonds

By Emma Trincal

New York, Nov. 9 - HSBC USA Inc.'s planned averaging notes with minimum return linked to the Dow Jones Industrial Average offer an attractive alternative to cash or even bonds, sources said.

The notes offer a return linked to the U.S. stock market with a 100% principal protection in addition to a 5% minimum return. This return is guaranteed regardless of the performance of the index and subject to the credit risk of HSBC, according to an FWP filing with the Securities and Exchange Commission.

The payout for the notes due Nov. 24, 2017 will be par plus the greater of the average index return and the minimum return. The return will be measured averaging the closing levels of the index on the 19th day of February, May, August and November during the life of the notes. The 5% minimum return amounts to an annual percentage yield of 0.71%.

Better than Treasuries

"It's not bad. Especially in today's low interest rates environment," said a market participant. "A three-year Treasury is about 60 basis points right now, so what's your opportunity cost?"

Earning only the minimum return is the worse case scenario, he said, besides not getting anything due to a default.

"If you buy something linked to a stock index, it's because you are bullish on the asset class. So hopefully, you're going to earn more than the minimum," this market participant said.

However, he said that the averaging method chosen to calculate the performance of the underlying index was not best for investors.

Averaging performance

"I'm not a big fan of averaging. I like point to point much better," he said.

"With averaging, you could end up with a flat return or almost no return. So that would be my concern with the notes."

The minimum return was another attractive aspect of the deal, a financial adviser said.

"Even if the market is down, you still get the minimum return" said Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management.

"I like it. I like the principal protection. And I like the minimum return.

"Seventy one basis points is a lot more than money markets these days.

"It's a good alternative to cash management. It may even be competitive with what the bond markets might yield over the next seven years."

Uncapped opportunity

Wright said that the payout structure offered another appealing feature: It was not capped.

"I've seen those quarterly average notes but with a cap on the upside. When there's no cap, I think it's good," he said.

One of the main risks, as described by the prospectus, is for investors to hold a note for seven years only to receive at maturity the 5% minimum return.

Such risk would be compounded if interest rates rose during the period, noted Wright. But giving investors exposure to the potential appreciation of the U.S. equity market is a way to hedge that risk, he noted.

"Hopefully, if interest rates are rising, it's because the economy is turning around and the stock market is doing well," he said.

Wright noted that the value of the notes depended on the investor's objective.

"If it's an alternative to what would sit in money market, [certificates of deposits], or bonds, I like it. If it's a substitute for stocks, then it's not that attractive," he said.

The notes (Cusip: 4042K1AJ2) will price on Nov. 19 and settle Nov. 24.

HSBC Securities (USA) Inc. is the agent.

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