Morgan Stanley's jump securities linked to Euro Stoxx 50 offer 100% minimum upside, big buffer

By Emma Trincal

New York, April 7 - Morgan Stanley's 0% buffered jump securities due April 30, 2024 linked to the Euro Stoxx 50 index offer an eye-catching minimum return of 100% as long as the index is up at maturity, making the investment suitable for moderately bullish long-term investors, sources said. In addition, the structure offers 40% downside protection.

If the index return is positive, the payout at maturity will be par plus the greater of the index return and the upside payment of $1,000 per $1,000 principal amount. Investors will receive par if the index declines by up to 40% and will share in losses beyond the 40% buffer, according to an FWP filing with the Securities and Exchange Commission.

Long term

"Wow! I like that note. The only thing I don't like is the term. Ten years is an awful long term," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"But of course you can't say you don't like the length of the notes because then you don't get any of the other good things. I understand that.

"I'm also not crazy about the concentration of the underlying index. The Euro Stoxx is a very narrow index, sort of the equivalent of the Dow Jones because it's only 50 stocks."

Other possible negatives are less of a concern, he said, in particular the exposure to the credit risk of Morgan Stanley, which has an A- rating from Standard & Poor's.

"The credit risk of Morgan Stanley doesn't really bother me," he said.

"Morgan Stanley is one of those too-big-to-fail institutions. After the Lehman debacle the government has made it clear that it would not let another one of those big banks go under."

On the positive side, Kunhardt said he likes the structure due to a combination of three factors: the minimum return, the uncapped participation above it and the 40% buffer on the downside.

Unusual structure

"I think this structure is pretty unusual in that they're giving you a rich upside with some minimum return and also a very big buffer on the downside. You often get return-enhancement types of notes or defensive notes, but you rarely get both. This one does. You get good terms both on the upside and on the downside. That's unusual," he said.

"The fact that all you have to do is be positive at maturity and you will get at least close to the long-term trend return of the market is pretty amazing. Plus the no cap on the upside. And the buffer. That is fantastic."

Should the benchmark finish positive, the 100% minimum return represents over 10 years about 7% per annum taking into account compounding, he noted.

"That's not bad at all," he said.

"And I like buffers. This one, a 40% buffer, is pretty impressive.

"I'm looking at our current offerings. Notes are shorter, but overall I'm seeing three-, five-, six-, six-and-a-half-year products and not one with a buffer. Every protection I see is offered through a barrier, and right now on our desk, all the barriers are 30% except a Credit Suisse which has a 40% barrier. I'm not seeing any buffer."

Given the benefits offered by the structure, investors should have no difficulty understanding the rationale behind the less appealing features, such as the notes' long tenor and the non-payment of dividends.

Forgoing dividends

"As part of the trade-off, you have this 10-year maturity. You also have to forgo dividends on a benchmark that pays very nice dividends," he noted.

The Euro Stoxx 50 has a 2.75% dividend yield.

"Over 10 years, it's more than 27.5% because it compounds. The value of what you're giving up depends on what your market growth assumption is. It could be substantial.

"But if you're investing in European stocks, are you investing for dividends or are you investing for capital appreciation? This would be for someone looking for capital appreciation and willing to roll out the dice in losing the dividends in order to maximize their capital appreciation. That's what it's all about.

"Will a conservative or moderate investor be willing to do that? Probably not. But an aggressive investor? Probably all day long. I have three or four clients at the moment who would love this if they can get past the 10-year [term]."

Euro run

Kunhardt added that he also likes the underlying asset class.

"It's a great time to enter the Euro Stoxx. Generally, the European stock market tends to follow the U.S. They took a while to come out of their recession, but they officially did come out of it in the fall of last year and have been recovering very nicely," he said.

"If you assume that they're trailing us as European stocks often do, they could be at the level we were in the beginning of 2009. You could have a pretty nice run if it's the case, capturing the value of those stocks coming out of their lows. You could be riding out the upside. You'll still get the market return if the rally is strong because you're not capped. If it's just modest or flattish growth, at least you'll get the 100%. And if you're wrong, you always have that buffer.

"The 10-year [term] of course is kind of long. That's the only thing. But I understand that this is what you have to pay to get all these benefits."

Don't forget dividends

For Tom Balcom, founder of 1650 Wealth Management, the long duration is not the only important concession investors have to make to benefit from the attractive payout. Giving up dividends has some implications investors should carefully assess prior to making their decision to invest, he said.

"It looks good to have this 100% jump, but you have to look at how they're able to get this," he said.

"You're missing on the dividends, and these are substantial dividends, especially over a long period of time.

"The only way this product would work would be if your index was up by less than 100%. In that case, you benefit from that jump payment, which is really some sort of digital payout. Depending on how moderately European stocks grow, you can outperform the index even without receiving the dividends.

"But you need to understand what you're giving up first.

"If a client thinks the market will be flat for 10 years, this is a nice way to outperform.

"But what if the index appreciates significantly? This product wouldn't work if the Euro Stoxx doubled over the next 10 years for instance because you're already behind having not received the dividends."

For mild bulls only

"With this kind of product, you have to ask yourself, in which market environment would such note work best?" he said.

"Obviously it's only if the index is up modestly over the next 10 years that you have a chance to outperform. I tend to be bullish, but it seems to be a little bit futile to forecast the market 10 years out.

"The only type of person or client who would want to buy this product would be someone who thinks that the next 10 years will be some sort of lost decade like the U.S. stock market was in the 2000s.

"In such an environment, you would be sure to do very well with these notes. If the European equity market was to be flat or only increase modestly, you would do a home run."

Interest rate risk

In addition to credit risk, investors are also exposed to interest rate risk. Both risks increase with longer-dated securities, he warned, focusing on interest rate risk.

"Should the client for whatever reason decide to sell prior to maturity, interest rate risk would be a concern," he said.

"This note is the combination of a zero-coupon bond and options. If rates spike, the bond component will decrease in price and the client may not be able to get a decent price on the secondary market. Even if you hold it to maturity as it's supposed to be the case with structured notes, clients still receive statements with mark-to-market pricing, and they read their statements monthly, quarterly. A spike in interest rate lowers the valuation of the notes, and the client is not going to be happy."

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61761JQB8) are expected to price April 25 and settle April 30.

© 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.