Morgan Stanley’s buffered jump notes on indexes seen as appealing for long-term investors

By Emma Trincal

New York, Oct. 3 – Morgan Stanley Finance LLC’s 0% dual directional buffered jump securities due Oct. 31, 2024 linked to the least performing of the Dow Jones industrial average and the Russell 2000 index offer more benefits than not, advisers said...as long as investors are comfortable with a five-year timeframe.

If the least performing index finishes at or above its initial level, the payout at maturity will be par plus the greater of the least performing index return and the upside payment of at least 28%, according to an FWP with the Securities and Exchange Commission. The exact upside payment will be set at pricing.

If the least performing index falls but finishes at or above the downside threshold level, 80% of the initial index level, the payout will be par plus the absolute value of the least performing index return.

If the least performing index finishes below the downside threshold level, investors will lose 1% for every 1% that the least performing index declines beyond 20%.

Minimum return

“This is a pretty interesting note,” said Steve Doucette, financial adviser at Proctor Financial.

“You’re long the index with a minimum of 28%. So you can outperform on the upside if the index is not up more than 5.5% a year.”

Investors are exposed to the worst-performing index, he noted. But the Dow Jones industrial average and the Russell 2000 are relatively correlated, being both U.S. equity benchmarks.

Worst-of on the downside

Another interesting aspect of the note was the downside payout.

“That 20% protection is a buffer. Plus, you’ve got the absolute return component. Most of them are barriers. I kind of like the note,” he said.

“The concept of a worst-of takes a different meaning on the way down.”

If indeed the least performing underlying declines by less than 20%, the “worst” of exposure turns out to be the best opportunity for investors since the return is delivered in absolute value.

“If you stay within the buffer range, this worst-of is actually a best-of,” he said.

More bearish

For Doucette, the note was more valuable in a bear market.

“The 28% jump is nice if you’re range bound in the next five years. But to me the real appeal is on the downside. There’s really a huge outperformance opportunity there.

“Whether you get the absolute return or breach the buffer, you’ll beat the market by a whole lot.”

Playing with time

But if the note is a better bet for bears than bulls, the timing of the trade may not be optimal.

“I like the note. I don’t like the duration.”

“I’d love to be able to get this in a three-year. It may blow up those terms if you shorten the duration. But I’d be curious.”

A potential bear market may be nearing based on historical patterns, he said. A chart from Ned Davis Research based on the S&P 500 index since February 1928 showed there is a bear market every 3.6 years.

“We’ve been 10 years into a bull. Obviously, a bear market is going to happen very soon,” he said.

Since bear markets are short-lived, a three-year maturity would probably enhance the benefits of the notes, he said.

“In the next five years we may go down and back up again although you never know about the timing. But based on history, we’ll probably be up from a bear cycle. If you shorten the note, you’ll capture its bearish component, which would be nice,” he said.

Hedge, income replacement

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, said the double benefit of the structure – boost on the upside and absolute return with buffer on the downside – had the potential to attract a wide range of investors.

“I like this deal,” he said.

“The upside gives you at least 5.5% a year. It’s not too far off from what we expect. Based on valuations, our own capital markets expectations are fairly in line with this... in the mid-single digit.

“On the flip side, you have this hedge and the buffer. That’s a really nice combination.

“This allows conservative investors to hedge a portion of their portfolio.

“Both clients looking for income and equity investors alike could use this as a substitute for their core exposure to the market.”

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61769HYG4) will price on Oct. 28 and settle on Oct. 31.

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