Morgan Stanley’s gears linked to Euro Stoxx 50 have aggressive cap, but vol, risk are high

By Emma Trincal

New York, Nov. 4 – Morgan Stanley’s 0% capped buffered gears due Nov. 30, 2018 linked to the Euro Stoxx 50 index offer a compelling return potential, but the notes end up scoring worse than average on the risk scale due to the volatility of the underlying index, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus double any index gain, up to a maximum return of 28% to 31%, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and lose 1% for each 1% decline beyond 10%.

Bullish

“This is more bullish than many leveraged notes we’ve seen,” said Vile.

In his model, Vile said he used a hypothetical cap of 29.5%, which is the mid-point of the range.

“You’re getting almost 14% a year compounded. With a participation of two, your index still needs to rise by 7% a year, which is pretty bullish in this environment.”

The Euro Stoxx 50, the benchmark for the euro zone equity market, is down 7.7% so far this year. The S&P 500 index is up 2%.

Underlying

“If you had the same structure but on the S&P, the terms would look pretty good. A 10% on a two-year with a 14% cap and two-times leverage would be very competitive,” he said.

“But this is not the S&P. The Euro Stoxx 50 is much more volatile, which is where the risk in the product is going to come from. You do have a 10% buffer, but the strength of a barrier or a buffer depends on the probabilities of closing above that level.”

The two-year implied volatility for the Euro Stoxx 50 is at around 22% versus 17% for the S&P 500.

Future Value Consultants provides research reports with scores on risk, return and price comparing each product to its peers – these notes belong to the leveraged return category – and to all products.

Market risk

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 2.91 market riskmap versus an average of 1.75 for leveraged return products, according to Future Value Consultants’ research report.

“We can certainly attribute this to the underlying. This index is more volatile than the S&P 500, and you have a lot of S&P leveraged notes, which we compare with this product,” he said.

“The 10% buffer looks good, especially on a two-year. But there may not be enough protection in there.

“If it was on the S&P, the market riskmap would be a lot lower.”

Credit

The credit riskmap is 0.57, higher than the 0.46 average for this product type.

“The notes are reasonably short-term. The fact that we have a bit more credit risk than average is probably due to the issuer’s creditworthiness,” he said.

At 92 basis points, Morgan Stanley’s credit default swap spreads are on the wider range of the scale among large U.S. banks, according to Markit.

Its spreads are slightly tighter than Goldman Sachs’ 95 bps but wider than Bank of America’s and Citigroup’s 82 bps, JPMorgan’s 64 bps and Wells Fargo’s 61 bps.

The riskmap, obtained by adding the two risk components, is 3.48, the report showed. It is higher than the 2.21 average score for the product type.

Risk-adjusted return

The return score measures the risk-adjusted return of a note. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The return score is 7.50 versus an average of 7.45 for similar products and 7.16 for all products.

“This is better than the same product type but not by much. It is clearly better than the average of all products,” he said.

“With that high riskmap, which pulls down the return score, it’s not a surprise that we end up with something just average. The 14% cap is attractive, but the risk is still high. Besides, you’re competing in the same category with notes that have no cap. Having a higher cap helps, but uncapped leveraged notes have an advantage.”

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

At 7.26, the price score is lower than the average for the same product type of 8.76.

“I’m surprised that it’s that much lower. Maybe it’s the term. It’s a short maturity, so you’re penalized on the fees measure per annum,” he said.

“It could also be due to the underlying. You still have a high level of risk. Maybe the issuer has not spent enough on the buffer.”

Overall

The notes have an overall score of 7.38 versus an average of 7.76 for all products and 8.11 for the leveraged return category.

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

“It’s good to average two scores because you can see the impact of the price score at the end. The short term of the notes and the volatility of the underlying pushed down the price score. It penalizes you on the overall.

“But at the same time you get a really good cap, some good leverage. The return score seems to indicate that you’re still fairly compensated for the amount of risk you’re taking.

“This note is for an aggressively bullish investor looking to outperform the market.”

Morgan Stanley & Co. LLC and UBS Financial Services Inc. are the agents.

The notes will price on Nov. 28 and settle on Nov. 30.

The Cusip number is 61766A566.

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