HSBC's autocallables tied to Russell 2000 ETF seen as income substitute, risk-reduction play

By Emma Trincal

New York, Nov. 10 - HSBC USA Inc.'s trigger phoenix autocallable optimization securities due Nov. 16, 2012 linked to the iShares Russell 2000 index fund may give investors an opportunity to add income to a portfolio and reduce exposure to equity risk, financial advisers said.

"If you're not a total bear, it may work for you. You'll be collecting some coupon," said Steve Doucette, financial adviser at Proctor Financial.

"I wouldn't mind having a coupon in exchange for not taking the full equity risk on the downside," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

The notes potentially pay a coupon on a quarterly basis depending on the closing level of the underlying small-cap index fund on given observation dates, according to an FWP filing with the Securities and Exchange Commission.

If the exchange-traded fund's shares close at or above the trigger price - 65% of the initial share price - on a quarterly observation date, the issuer will pay a contingent coupon for that quarter at the rate of 10% to 12.5% per year. Otherwise, no coupon will be paid that quarter. The exact contingent coupon rate will be set at pricing.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par of $10 plus the contingent coupon.

If the notes are not called and the ETF finishes at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Low risk and income

Doucette said that the notes would be appropriate for someone with a low tolerance for risk.

"The sad part is that you're exposing yourself to 100% downside for a coupon," he said.

"But you have a 35% protection. It's pretty good. It's relatively low risk, and you can collect good income.

"Now if you're apocalyptic, if you see the market dropping 50%, you wouldn't go there."

Doucette said that one of his goals is to be an "asset allocator" for his clients.

"We look at these notes and we see them as a way to add or reduce exposure to a given asset class," he said.

"We've done notes like that before. We see them as a bond replacement strategy."

Even though the notes are riskier than a traditional fixed-income security, the 35% cushion on the downside diminishes the risk a lot, he said.

"And chances are you're going to collect a better coupon than what's out there.

"Replacing a pure bond exposure is particularly important in a rising rates environment where bonds are going to lose money. That's how we use those autocallable notes," he said.

Doucette said that knowing when to invest in the notes is the difficult part.

"The good time would have been a month ago when we were down 10%. These are the times to buy those autocallables. Is now a good time? That's a tough call," he said.

"But we think it's a reasonable risk, and if it's not, we can unwind this note at a higher price than 35% down," he said.

Doucette said that he is comfortable selling structured notes he owns on the secondary market, asking the issuer for bids prior to maturity.

Reducing volatility

For Medeiros, the notes offered value as a way to get reasonable upside without full exposure to the market on the downside.

"Philosophically speaking, if I'm going to take equity risk exposure, I would want to get the benefit of equity returns," Medeiros said.

"In this case for instance, if the index goes up, I might not get the full benefit. I'm just getting the coupon.

"But safety is paramount.

"We think there's a good probability for the Russell 2000 to go up, maybe by more than 12%, but I'm just not going to jump in right now.

"With the volatility being so high, I wouldn't be taking much of a position at this point.

"So I wouldn't mind. In fact, I would be satisfied in just taking the coupon without taking the full volatility exposure."

The notes (Cusip: 40433C163) were expected to price Friday and settle Wednesday.

HSBC Securities (USA) Inc. is the underwriter with UBS Financial Services Inc. as agent.

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