Morgan Stanley offers global recovery leveraged product; basket reduces volatility: adviser

By Kenneth Lim

Boston, June 25 - Morgan Stanley's leveraged notes linked to a basket of global stock and commodity benchmarks offers an alternative to investing in each component index, an investment adviser said.

Morgan Stanley plans to price a series of global recovery zero-coupon Performance Leveraged Upside Securities due Jan. 27, 2011 linked to a basket of exchange-traded funds and bond indexes.

The basket includes 16.667% weights of the iShares Russell 2000 index fund, Technology Select Sector SPDR fund and iShares MSCI Emerging Markets index fund; 15% weights of the iBoxx USD Liquid High-Yield index and the iBoxx USD Liquid Investment-Grade index; as well as 10% weights of the iShares Dow Jones U.S. Real Estate index fund and the PowerShares DB Commodity Index Tracking Fund.

The payout at maturity will be par of $10 plus 200% of any basket gain, capped at 123% to 127% of par. The exact cap will be set at pricing. Investors will share in any losses.

Recovery theme

The product's accelerated participation on the upside and the choice of underlying funds and indexes mark it as a recovery investment, the investment adviser said.

"When I look at the basket I see small caps, emerging markets, tech, high yield, real estate, commodities," the adviser said. "All of them have taken a beating, especially real estate and commodities.

"Small caps and emerging markets, these are the early movers in a recovery or a downturn. If you think there's a recovery coming, you're interested in those early movers and sectors that may have corrected more because there's potentially more upside there."

The grouping of the indexes and funds into a basket could help to lower the volatility of the product for investors, the adviser said.

"I think the underlying volatility will definitely be lower than each individual fund," the adviser said. "I could go out and buy $16,667 of the Russell 2000, $16,667 of the Technology SPDR and so on to get the same effect, but it's inconvenient and I may not even save much when I take into account transaction fees."

But the large number of basket components and the diversity could make it difficult for an investor to form a strong opinion about the underlying.

"If you ask me where the Russell 2000 is going to be in 18 months I can probably make a more confident guess than if you ask me where a basket of seven ETFs is going to be in 18 months," the adviser said.

Relative cap

The adviser noted that the cap could be a concern for some investors. Those who think that the basket will gain more than the capped return will naturally want a higher cap. Investors who are looking for an investment to make back losses from the past two years could also be seeking a higher rate of return.

"It boils down to what your goal is," the adviser said. "For most investment objectives, a 23% to 27% return in 18 months will easily make the target. Personally I think it's a great return. There's sometimes a temptation to be greedy, but there's no such thing as a free lunch. If you want a better return, you have to take on more risk, so as an investor you have to pick."

The lack of principal protection did not faze the adviser, who said that the downside exposure is comparable to directly buying the basket components.

"If I think the Russell 2000 is going to recover by the next 18 months, I could buy the ETF or I could buy this," the adviser said. "You can compare the upside versus the downside. The downside is the same for both, it's a straight one-for-one. On the upside, because the leverage is 200%, I outperform the ETF until I hit the cap. But if I don't expect the basket to go above the cap, I'm not concerned about underperformance."

© 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.