HSBC's market notes tied to S&P 500 Low Volatility offer volatility play with some protection

By Emma Trincal

New York, Dec. 6 - HSBC USA Inc.'s 0% buffered uncapped market participation securities due Dec. 28, 2015 linked to the S&P 500 Low Volatility index offer investors exposure to a low volatility strategy with some partial downside protection, but the absence of any return enhancement is seen by some as a drawback.

The payout at maturity will be par plus any index gain, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% to 15% and will lose 1% for every 1% decline beyond the 10% to 15% buffer. The exact buffer will be set at pricing.

Long the upside

"They introduce a low volatility index and the protection. Everything in this deal is about the low volatility strategy, the underlying index and the protection. But there's nothing on the upside," said Steve Doucette, financial adviser with Proctor Financial.

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he did not mind the one-for-one exposure to the index on the upside, which he noted was uncapped.

"Once you enhance the index on the upside, you'll have to change the buffer characteristics and it will affect pricing. I like that 10% to 15% buffer on a point-to-point basis over a three year period," Medeiros said.

"You get the long exposure to this index. As long as the fees aren't too much of a drag, it's nice to have the assurance that you have the downside buffer."

The underwriting fees were not disclosed in the prospectus.

Low vol. strategy

The S&P 500 Low Volatility index measures the performance of the 100 least volatile stocks over the previous year in the S&P 500 index. It is designed to serve as a benchmark for low volatility strategies in the U.S. stock market, according to the prospectus. It was first published on April 20, 2011.

When stock prices are falling and volatility is up, the underlying index is expected to outperform the S&P 500.

A table in the prospectus showed that the annual returns of the S&P 500 Low Volatility index were better than those of the S&P 500 index in down years, based on hypothetical backtesting.

In 2000, the S&P Low Volatility index gained 20.68% versus a 10.14% negative return for the S&P 500.

In 2008, another bear market year, the low volatility index was down 23.61% while the regular benchmark lost 38.49%.

In a bull market year, such as 2009, the S&P 500 outperformed the S&P Low Volatility index.

In 2009, for example, the traditional benchmark was up 23.45% while the low volatility index rose by 15.52%, according to the prospectus.

The fee factor

"I like the index. I like the asset class. I think the buffer is fair," said Medeiros.

"A low volatility strategy in a three-year period should perform well relative to the S&P. At least, it's much more predictable.

"Again it all depends on what the fees are going to be. If it's not too onerous, I don't mind the small premium for the peace of mind of getting exposure to this index with some downside protection," he said.

Doucette on the other hand said that he was not interested in the notes, since they merely track the index on the upside.

"It's simply a way to get equity exposure with less volatility and some protection. It's boring," he said.

"Rather than being long low volatility with no form of return enhancement, I'd much rather get a coupon.

"I play volatility strategies but in very different ways. For instance, I use other notes to arbitrage between short-term volatility and long-term volatility.

"This is supposed to be a more protective structure thanks to the buffer. But the index itself is not going to protect you against losses. If the market goes down, you will go down less but you will still be going down. There is no real hedging.

"And if the market is up you give up an awful lot of the upside.

"If I have to get locked in for three years just for the protection, I'd rather collect some coupon," he said.

HSBC Securities (USA) Inc. is the agent.

The notes will price on Dec. 20 and settle on Dec. 26.

The Cusip number is 40432X5E7.

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