HSBC's 50/150 performance notes tied to S&P 500 Low Volatility: longer tenor is seen as a plus

By Emma Trincal

New York, Aug. 5 - HSBC USA Inc.'s 0% 50/150 performance securities due Aug. 30, 2019 linked to the S&P 500 Low Volatility index are longer in duration than many leveraged, principal-at-risk products, sources said. But the longer tenor was not seen as a drawback. In fact, sources said that the six-year term may be beneficial to investors given the type of index being used and the length of market cycles.

If the index finishes above its initial level, the payout at maturity will be par plus 1.5% for every 1% gain. Otherwise, investors will lose 0.5% for every 1% decline, according to an FWP filing with the Securities and Exchange Commission.

The S&P 500 Low Volatility index measures the performance of the 100 least volatile stocks in the S&P 500.

Six years works

"A lot of people aren't going to like it because six years is a long time," said Michael L. Kalscheur, financial adviser at Castle Wealth Advisors, LLC.

"I tend to think the opposite.

"Most clients want to be invested long-term, but they sometimes need the discipline to do it - that's why they need advisers. This type of investment forces people to do what they know they should do, which is to invest some of their capital long-term and forget about it. This is long-term money.

"The longer the term of the notes, the less emphasis I put on the downside protection in general. But it's even more the case with this particular index, which tends to outperform the S&P during market downturns.

"To begin with, you have a very good downside protection. You take half of the losses.

"And then, looking back on a six-year rolling period, [look at] how many times the low volatility index has been negative. My guess is that it has not happened very much unless you look at starting points like 1995 or 1996.

"The chances of this index going down after six years in my opinion are very small."

For Carl Kunhardt, wealth adviser at Quest Capital Management, the credit quality of the issuer was "the most important thing" to consider for a six-year structured note.

"It's single A+. That's fine with me. Since the U.S. and other sovereigns have lost their triple-A, it had a domino effect on the corporations and the banks of those countries, and basically, there is no triple-A anymore. So the credit issue is off the table," he said.

"The six-year [term] doesn't really bother me. It's intermediary. I have uncapped leverage on the upside. They're giving me 50% protection on the downside. It's a core equity position. I can look at it as part of my equity allocation."

Outperforming the S&P

The willingness to extend maturity to a six-year term depended in part on investors' outlook. For those who do not foresee the continuation of the same bull market of the past four years, the notes tied to a more conservative index should tend to reduce risk, said Kalscheur.

"I believe that we'll see some kind of correction within the next six years. I don't know when it's going to be and how bad. But I would be inclined to put money in the S&P 500 Low Volatility because it's likely to outperform in a down market," he said.

When using the S&P 500 Low Volatility index, investors are better off over a longer period than with the S&P 500, said Kunhardt.

"The longer you go, the less different the performance between the two indexes is going to be because you start to capture bad markets. The more down markets you capture like 2008 or 2001-02, the more the Low Volatility will outperform the straight index," he said.

The S&P 500 Low Volatility index has only been calculated since April 2011, but a hypothetical annualized return table in the prospectus compared the S&P Low Volatility index performance with that of the S&P 500 as of June 28.

It showed a trend: the Low Volatility index outperformed the S&P 500 over longer periods including down markets.

For instance, in the past 12 months, the S&P 500 Low Volatility index gained 12.84%, compared with 17.92% for the S&P 500 index amid a very strong bull market. But in the past five years, the S&P Low Volatility index, with a 7.70% return, outperformed the S&P 500 by 305 basis points.

Over the past 10 years, the S&P Low Volatility index was up 6.44% and the S&P 500, 5.12%.

For Kunhardt, the exposure to the Low Volatility index was part of a trade-off.

"When you choose the S&P 500 Low Volatility, you have exposure to a U.S. large core position. It's basically a portfolio of blue chips. But you're getting rid of the high-volatility stocks, which are supposed to outperform in a bull market," he said.

"This choice falls into your market outlook. How bullish are you and are you willing to give up the upside, say the 400 basis points of outperformance from the S&P when the market rallies? If you're giving that performance differential, the downside protection has to be sufficient to warrant that.

"You need to look at the 400 basis points as a straight opportunity cost and ask yourself, Am I willing to give up 400 basis points of potential upside in order to get a protection of 50% of your value?

"I'd say any day, every day."

Value to come

Another reason to invest over a longer timeframe in the S&P 500 Low Volatility index, Kunhardt said, was related to the current market cycle.

A majority of the stocks in the index, he noted, are dividend-paying stocks.

"Those stocks tend to offer value compared to growth," he said.

Utilities make for 30.17% of the index while information technology is only 2.76%, according to the prospectus.

"I see those value stocks outperforming looking forward. We have been three years into the recovery, and we should have started to see a shift from growth to value. But we haven't seen that shift yet. We haven't really had the full recovery. Growth is still outperforming.

"The longer the term at this particular point in time, the longer value will tend to outperform growth," he said.

Kalscheur said he liked the terms as well as the simplicity of the structure.

"It does reduce my downside, not only because of the index but also because of the 50% downside protection," he said.

"It's not a buffer, and I may prefer a buffer. For instance with a 10% buffer, if the market is down 10%, you lose nothing, whereas with this, you would lose 5%. But it's still really good because you can go back to the client and tell him, We did protect you.

"The 150% upside is also great. I think that over a six-year period, you have a pretty good chance of being significantly positive at the end of the period. So if you get 10% a year, that's 60% after six years and a 90% return on your note. I'll take 90% on a six-year any day of the year."

Investors have to give up something to obtain those attractive terms, he noted.

"My real issue is the yield you're giving up compared to the S&P 500," he said, comparing the 2.78% dividend yield on the Low Volatility index with the 1.98% on the S&P 500.

"You're giving up almost one percentage point in performance per year compared to the S&P 500. So it's something to keep in mind.

"But if you think the market is fairly priced, maybe a little bit overpriced, putting your client's money in a conservative index for a six-year period will allow the investment to grow nicely. It's an easy way to have people sit tight and take care of their long-term investment needs.

"In that way, it makes a lot of sense."

HSBC Securities (USA) Inc. is the agent.

The notes will price on Aug. 27 and settle on Aug. 30.

The Cusip number is 40432XJX0.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.