HSBC’s leveraged buffered notes linked to PowerShares S&P 500 offer low-volatility strategy

By Emma Trincal

New York, April 13 – HSBC USA Inc.’s 0% leveraged buffered uncapped market participation securities due April 23, 2018 linked to the PowerShares S&P 500 High Dividend Portfolio offer investors exposure to a low-volatility, high-dividend strategy some investors may seek as a way to reduce risk.

But sources debated the pros and cons of using a note rather than a fund in order to get access to the low-volatility strategy.

The payout at maturity will be par plus at least 1.1 times any fund gain with the exact participation rate to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 15% and will lose 1% for every 1% decline beyond 15%.

The underlying fund tracks the return of the S&P 500 Low Volatility index, which is a measure of the performance of the 50 least-volatile, high dividend-yielding stocks in the S&P 500 index.

Cornerstone

Carl Kunhardt, wealth adviser at Quest Capital Management, said he likes the notes mostly for the underlying theme.

“This is right up my alley. I use this type of fund as a cornerstone for building up a U.S. portfolio,” he said.

“You want to have an allocation to low-volatility, low-beta and high-dividend stocks. With a six-year bull market and the concern of rising market volatility, you have to start looking for ways to mitigate risk with low-volatility funds.”

Passive management, he noted, is the most efficient way to implement these types of strategies because they can provide clients with a less-expensive investment and therefore extra value.

Kunhardt said he invests in two low-volatility ETFs. One is the PowerShares fund used in the notes, and the other is the iShares MSCI USA Minimum Volatility ETF.

“I like the iShares better because there’s more liquidity, but the PowerShares and the iShares are very similar,” he said.

“I’m going to have that low-volatility, high-dividend strategy as a cornerstone of my portfolio anyway. These are the blue chips. If you’re not investing in that, you’re speculating.”

Term

Kunhardt said the term of the notes is not relevant.

“Given that I’m investing in this type of portfolio anyway, it doesn’t matter if I’m going to be invested for three years, five years or seven years,” he said.

“Actually, the longer, the better because the longer you are invested in the index the less likely you are to have a negative return.”

ETF versus notes

The “only real question” in his view is whether to invest in low-volatility and high-dividend strategies through an ETF or via a structured note, such as the HSBC product.

“You’re getting a little bit of leverage on the upside, a true buffer on the downside,” he said.

“My only negative is the cost of the structured note, which is one of the reasons I wouldn’t do the entire investment in it. There is another reason, which is the lack of dividends.”

Investors in the notes are willing to forgo dividends or other distributions paid to holders of the underlying ETF, according to the prospectus.

The fund carries a dividend yield of 3.25%.

“I may do one-third in the note only and the rest in the ETF,” he said.

Giving away too much

For Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, not getting paid the dividends from the underlying fund is a deal-breaker.

“Why would I be interested in a note tied to a high paying-dividend index if I’m not going to get any dividends?” he said.

“We know that dividends contribute to half of stock returns, so why would you take that away? It’s like investing in high-yield bonds and not taking the interest. I don’t see the point in doing that.”

He added that selecting high-dividend stocks means earning less in price appreciation compared to growth stocks.

“You’re taking more than just half of the performance out because you’re also investing in high-yielding stocks, which tend to show less potential for price appreciation than growth stocks. It’s like giving up the best of both worlds,” he said.

“When you buy this note, you agree to give up 3.25% per year during the three-year term. You know you’re not going to get the dividend, and you can expect a much lower return from the capital appreciation.

“I don’t see any upside to this investment.

“The buffer is nice, the 1.1 leverage is nice, but what’s really nice is if you get the dividends.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on April 17 and settle on April 22.

The Cusip number is 40433BP44.

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