HSBC’s notes on PowerShares S&P 500 High Dividend to potentially outperform S&P 500

By Emma Trincal

New York, Feb. 2 – HSBC USA Inc.’s 0% buffered uncapped market participation securities due Feb. 6, 2020 linked to the PowerShares S&P 500 High Dividend Portfolio exchange-traded fund make for a strong product based on the underlying asset class, which should outperform the large-cap U.S. market and its structure, a financial adviser said.

The payout at maturity will be par plus 120% of any fund gain, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 20% and will lose 1% for every 1% decline beyond 20%.

Underlying strategy

Carl Kunhardt, wealth manager at Quest Capital Management, said that he already invests in the low-dividend and high-yield strategies.

“I’m familiar with this fund and it’s one of the strategies that I use. There are two other funds I also use: one is the iShares Core High-Dividend Equity fund ETF, ticker HDV; the other is the USMV, or the iShares USA Minimum Volatility ETF,” he said.

“The PowerShares is somewhat of a combination of the two.”

The underlying fund measures the performance of the 50 least-volatile, high dividend-yielding stocks in the S&P 500 index. It is designed to achieve a balance between dividend yield and volatility, according to the prospectus.

“The two iShares ETFs have a 75% correlation. They overlap by 75%. And the PowerShares has an 82% correlation with the Minimum Volatility fund and 86% with the Core High-Yield Dividend. The PowerShares provides a good proxy for those two strategies,” he said.

Large-cap, value

Kunhardt said the two iShares ETFs are both “large-cap, value-driven funds” and “so is the underlying fund in these notes.” The only difference, he said, is that the PowerShares “goes down on the capitalization scale a little bit more,” making the ETF slightly more volatile.

“But I like this fund a lot. It’s a large cap, very value-driven ETF. That fits right into our outlook. We think large-caps will outperform small-caps and we expect a shift from growth to value.

“It’s simply a matter of valuation. Small-caps and mid-caps are over-valued right now compared to large-caps.

“You have to pick the funds you believe will outperform based on where in the market cycle you find yourself.

“As we enter a slow cycle, the shift from small-cap to large-cap will validate the shift from growth to value.”

“When we pick a note, we carefully look at the underlying first. Here is an ETF that invests specifically in the large-cap, value-driven space and pays high dividends. You’ve just checked off all the boxes I’m looking for in an investment.”

The PowerShares S&P 500 High Dividend Portfolio ETF posted a 20% gain last year versus 14% for the S&P 500 index. In 2013, the S&P 500 rose by 33% while the ETF gained 21%.

Terms

Kunhardt said the terms of the notes were also attractive.

“They’re not going to cap it. They’re going to give you a buffer. This is pretty attractive. Plus you’re getting to leverage up but not leverage down. That’s sugar in my coffee.

“If I was going to design a note in the mega-cap, value-driven U.S. domestic space with that type of structure, that’s exactly what I would do,” he said.

Fabrice Hugon, senior managing director-structured products at Elkhorn Investments, explained how the issuer was able to price the terms.

“The underlying yield is high. Investors in the notes don’t get paid any dividends. As an issuer, you can use the dividends to buy more optionality,” he said.

The dividend yield on the PowerShares S&P 500 High Dividend Portfolio ETF is 3.27% versus 1.87% for the S&P 500 index.

“If you don’t take the dividends into account, the forward value is going to be lower.

“As a result it’s cheaper to buy the options,” he said.

In addition, the longer five-year tenor made the pricing easier too.

“It helps. There are more rates to play with,” he said.

“They can give you a no-cap and a buffer with leverage.

“The combination of rates and yield is what’s going to make it appealing. There is no free lunch.”

HSBC Securities (USA) Inc. is the agent.

The notes are expected to price on Feb. 3 and settle on Feb. 6.

The Cusip number is 40433BA24.

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