Morgan Stanley links to healthcare ETF; retail seeks familiarity, outperformance in sectors, adviser says

By Kenneth Lim

Boston, Oct. 28 - Structured notes that are linked to specific market sectors could be interesting for investors who are seeking ways to outperform the general market, an investment adviser said.

"The idea is that surely not all industries will be affected in the same way, so if you can identify which industries those are, you could improve your chances of beating the market," the adviser said.

Morgan Stanley on Tuesday offered a series of notes linked to a healthcare exchange-traded fund that has not been seen recently.

Morgan Stanley is planning zero-coupon performance leveraged upside securities due May 20, 2010 linked to the Healthcare Select Sector SPDR fund.

At maturity, investors will receive par plus triple any gain in the underlying fund, up to a maximum payout of 129% to 131% of the principal. Investors will lose 1% for every 1% that the fund declines at maturity.

The exact payout cap will be set at pricing.

The Morgan Stanley notes will be offered at par of $10.

Sectors easier to understand

Retail investors could be interested in products that are tied to market sectors instead of broad indexes because they could be more familiar with certain sectors, the adviser said.

"Just because it's a smaller universe to keep track of," the adviser said. "A small retail investor might, for whatever reason, find it easier to get a better understanding of a sector, which maybe has 25 companies, compared to the S&P 500, which has 500 stocks. It could be it's easier to understand something that's smaller, or maybe the investor works in the healthcare sector, for example, and is more intimate with the sector."

Investors could also be interested in sector-linked notes because they hope to do better than the broader market, the adviser said.

"I think there's certainly some truth to that," the adviser said. "There's never a recession that will hit every sector equally. If the economy is down, universities and business schools do better, the repo business is better, just off the top of my head.

"If you just buy the S&P 500, your fortune is tied to the average market performance, which means you take a share of whichever sector is doing poorly. But if you can find a way to only expose yourself to the sectors that do better than average, then you can potentially outperform the market."

Riskier investments

But sectors tend to be more volatile than broad market indexes, the adviser said.

"In general, the volatility of the S&P 500 will be lower than the volatility of a group of stocks within the S&P," the adviser said. "That's because correlations are higher within a sector."

The higher volatility implies that products linked to sectors are likely to be riskier than similar offerings tied to broad indexes, the adviser said.

"All else being equal, yes, a note linked to a sector should be riskier than a note linked to the S&P 500," the adviser said.

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