Morgan Stanley’s autocallable jump notes linked to Russell, Dow designed for targeted return

By Emma Trincal

New York, Oct. 7 – Morgan Stanley Finance LLC’s 0% jump securities with autocallable feature due Oct. 13, 2022 linked to the lesser performing of the Russell 2000 index and the Dow Jones industrial average give investors a fair chance to earn a 10% return in one year with a good risk-adjusted return, advisers said.

“I would consider it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“There are a little bit too many pieces. Clients like it simple. But it may be a better alternative to a long position.”

The notes will be automatically called at par plus a call premium of 10% per year if each index closes at or above its redemption threshold level on either annual determination date, according to a 424B2 filing with the Securities and Exchange Commission.

For each index, the redemption threshold level is 100% of its initial level for Oct. 13, 2020 and 95% of its initial level for Oct. 7, 2021.

If the notes have not previously been redeemed and the final level of each index is greater than or equal to 90% of its initial level, the payout at maturity will be par plus 30%.

If the final level of either index is less than 90% of its initial level but the final level of each index is greater than or equal to its downside threshold level, 70% of its initial level, the payout will be par.

If the final level of either index is less than its downside threshold level, investors will lose 1% for every 1% that the lesser-performing index declines from its initial level.

Downside scenario

“You’re talking about large caps small caps ... two basic asset classes you’re going to hold in your portfolio anyway,” said Kunhardt.

“How you view a note depends on your view of the market conditions. Right now, there is a lot of uncertainty.”

Investors have to compare the possible outcomes of a structured product with a long position in the market, he said.

Having an idea of whether the Dow Jones industrial average or the Russell 2000 will be the worst-performing index is helpful given the payout, he noted.

“I see the Russell as the one to drive volatility on the downside,” he said.

“But I don’t see it breaching the 30% barrier. The note gives me some protection compared to being long the index. If the market is down 20%, I’m not losing anything, so I’m better off.”

Upside

If both indexes are up, Kunhardt envisioned the Dow Jones industrial average to be the laggard.

“In this upside scenario, I get my principal plus my return depending on the call feature,” he said.

“I don’t really like call features. But if the market is up, regardless of how much, I get 10%.

“Then you go to the second year. You get 20% but the trigger point is 95%. If I’m down 5%, it’s an absolute return gain. It’s a tiny probability, but it doesn’t matter anyway because I don’t think I’m getting that far. I’ll be called on the first year. A second year call is unlikely and a third year call, even less likely.”

Call risk

The most likely outcome, for this adviser, was a call with a 10% premium after one year.

“Now you take the reinvestment risk. It’s after one year, not three months, which is better,” he said.

“Having to reinvest your proceeds in a different market environment doesn’t seem like a big deal, especially after making 10%. Still it’s something to keep in mind.”

Likely call

Michael Kalscheur, financial adviser at Castle Wealth Advisors, felt very comfortable with the downside protection.

Using back testing data he has available on those two indexes (since 1985 for the Dow Jones industrial average and 1987 for the Russell 2000), he examined the frequency of specific outcomes.

The Dow over a one-year period was flat or positive 80% of the time, and it occurred 74% of the time with the Russell 2000.

“Of course you have the worst-of component. Some mathematical adjustments would have to be made,” he said.

“You probably have a 70% chance between the two combined to be taken out over year one. That’s a pretty high probability in my book.”

Investors had an additional chance to be called on the second year and at maturity. But statistically, the odds of an early redemption are the greatest on the first call date, he noted.

“It’s one of those things I would feel very comfortable telling the client ... you’ll probably be called at the end of the first year.

“If you’re not, at least it’s cumulative, so it’s not like you’re missing an opportunity if you miss one call.

“Is 10% a competitive return? I would say yes.”

The downside risk was limited thanks to the barrier.

“The chances of being down 30% or more after three years, you’re talking single digits, probably less than 5%,” he said.

“So the 30% barrier over that period ... I feel very confident about that too.”

Not a growth note

What made this adviser less “confident” was the risk of missing some of the upside if the bull market continues.

The chances that either one of the indexes could be up more than 10% over a 12-month period are about 53%, according to his data.

“This is a very impressive product, better than some of the other things I’ve seen lately.

“If you have a range-bound view, this note definitely has merits and has a place in the portfolio.

“But it’s only for someone who isn’t overly bullish.”

Kalscheur said he would not buy the note as a “standalone” investment but rather as a complement to an equity position or a levered buffered note.

“This is not a product designed to outperform the market. It’s not a substitute to a levered note,” he said.

“But if you have a return target in mind, it gives you a decent chance to get it.”

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will settle on Thursday.

The Cusip number is 61769HC37.

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