Test drive: HSBC 100+ Series International Equity Investment
Safety net … HSBC's new product takes the risk out of plunging into foreign waters. Photo: Peter Riches
What is it? HSBC has launched a capital-protected equity investment product - 100+ Series International Equity Investment. It is designed for investors who want exposure to equity markets but are concerned about losing money if volatility continues. Investors gain exposure to four markets - Australia, Switzerland, Singapore and Taiwan.
Returns are an average of the performance of those markets.
The investment term is five years and at maturity, investors are guaranteed a minimum return of their capital outlay. Investors choose between two options: capital growth at maturity or annual income.
The head of sales for global markets at HSBC Bank Australia, Ian Collins, says the chosen markets were all listed as ''overweights'' by HSBC's global equity strategy team in its 2012 equity strategy review.
HSBC has been offering its 100+ Series investments since 2008 and has been doing two or three a year.
Other regular issuers of capital-protected investment products include Macquarie Group, Citigroup, Westpac and the Commonwealth Bank.
How it works Capital-guaranteed investment products use derivatives of one kind or another to lock in a return of capital. In this case, HSBC uses the bulk of the funds invested to buy a zero coupon bond; this is a bond that's sold at a discount to its face value but repays the full face value at maturity. That locks in the return of capital.
The balance of the invested funds is used to buy options over the market indices - the S&P/ASX 200, the Swiss Market Index, the MSCI Singapore Free Index and Taiwan's TAIEX Index.
These options track the movement of the underlying markets.
For investors who have chosen the capital-growth option, the return is calculated by recording the levels of each index on seven dates in the six months before maturity.
These are used to calculate an average closing level. The final return figure is an equally weighted average of the closing levels of the four equity markets.
For investors in the income option, the percentage change from the start date to each anniversary date for each of the four indices is averaged and that percentage change is the income return.
Capital and income returns are capped (this is an effect of the use of options). The maximum capital return at maturity is $2 for every $1 invested, so the maximum maturity amount is $3 ($2 growth return plus $1 return of capital). The income cap is 11.8 per cent a year.
The bottom line is that capital investors stand to make a $2 return on every dollar invested, at best, and get their money back, at worst. Income investors stand to make 11.8 per cent a year, at best, or get their money back with no annual income, at worst.
The cap rates quoted here are the ones used for illustrative purposes in the product disclosure statement.
HSBC will not finalise the cap rates until the issue date.
Pros The big plus with this type of product is the capital protection. World equity markets plunged in 2008, made a partial recovery in 2009 and have been moving sideways since. At some point, there will be another bull market.
Capital protection is a valuable tool for investors who want exposure to a new bull market but do not want to risk further losses along the way.
There are no fees. HSBC pays a 3 per cent commission to advisers and other intermediaries but that money does not come out of the investor's funds.
But the real cost of this investment is the opportunity cost (see below).
Investment returns are calculated and paid in Australian dollars, which eliminates any foreign-exchange risk on the international equity exposure.
Capital-protected investment products can be fully geared, which makes them tax-effective investments.
Cons The capital protection is available as long as the investor holds the investment for the full five-year term.
If the investor has to get out early, HSBC will calculate a break cost with reference to market levels and prevailing interest rates. The effect is that the investor loses the capital protection. HSBC has the discretion to allow investors to exit early.
Collins says it would be very unlikely that investors would not be allowed to get their money out early.
Another drawback is that the caps limit the investment's upside potential.
Investors who take a view that markets are going to grow strongly in the next five years may not wish to be limited in this way. The impact of the cap is called an ''opportunity cost''.
One uncertainty is that the actual cap levels will not be determined until the issue. The product disclosure statement says: ''HSBC's determination of the cap will be influenced by the prevailing market conditions, such as Australian interest rates and the volatility of the reference assets [the four equity indices].''
The chief executive of Alpha Structured Investments, managed investment analyst Tony Rumble, says one of the drawbacks of the type of structure used by HSBC is that options contracts don't allow for the payment of dividends to investors.
Income investors will also receive no tax benefits from franking credits. This means investors are being asked to put up their money without knowing what their maximum potential return is.