Morgan Stanley’s trigger notes tied to Euro Stoxx 50 with 5x gains can outperform in bull market

By Emma Trincal

New York, Dec. 14 – Morgan Stanley Finance LLC’s 0% trigger Performance Leveraged Upside Securities due Jan. 5, 2022 linked to the Euro Stoxx 50 index offer high potential return, but advisers look at the downside risk with scrutiny at this stage of the market cycle.

If the index finishes at or above its initial level, the payout at maturity will be par plus 500% of the gain, up to a maximum return of 77.65%, according to an FWP filing with the Securities and Exchange Commission.

If the index falls but finishes at or above the 75% trigger level, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline.

High gearing

It is rare to see leveraged notes with participation rates of 500% or greater. Yet Morgan Stanley has been following this path recently. Two weeks ago, this agent priced on the behalf of HSBC USA Inc. $11.27 million of Euro Stoxx 50 index-linked notes due April 6, 2021 with 9.5 times the upside index gain. The cap and barrier levels were 152.5% and 85%, respectively.

The use of the Euro Stoxx 50 index allows better leverage pricing than the S&P 500 index, sellsiders say.

Forward contracts on the Euro Stoxx 50 index are cheap at the moment due to Europe’s lower interest rates and higher stock dividends. Cheaper forwards in turn reduce the cost of purchasing the calls for the leverage.

Term, cap

“The four year is a little bit of a long time. But obviously you have this very high leverage with a pretty neat cap,” said Steve Doucette, financial adviser at Proctor Financial.

The 77.65% cap represents a 15.45% annual return on a compounded basis. Because the notes are highly leveraged, the index only has to rise by 3.65% a year to bring the final return to its maximum level.

“It’s a great cap based on where we are in this market cycle,” he added.

“Everybody is expecting muted returns going forward. And 15% a year is not a muted return. So despite the cap, you’re pretty likely to outperform on the upside thanks to that huge leverage,” Doucette added.

Bear coming

But the market also expects a correction within the next four years if not a bear cycle.

“Then it comes down to timing,” he said. “Do we go through a bear and then come back all the way up within the next four years? It’s hard to predict beyond three years. That’s why we usually like to stick to three years or less.

“At this point the market is up and we don’t know how long the momentum is going to be.”

Transforming the notes to replace the barrier with a buffer would probably alter the payout in an attractive way, he said.

“The cap and the leverage are both pretty appealing. If you did a buffer you’d be giving up a lot of one or the other. Probably both,” he said.

In conclusion Doucette said he liked the upside. It is up to the portfolio manager to do his “due diligence” and try to determine the odds of “getting caught in a bear market,” during the term.

“You have to be confident that the 25% protection will be enough. And it is a neat protection. I kind of like this note because you are almost sure to outperform on the upside and you’re still covered on the downside by up to 25%.”

Positive outlook

Matt Medeiros, president and chief executive of the Institute for Wealth Management, who is bullish on the Euro Stoxx 50 index, liked the upside payout. But pointing to some risks inherent to the European equity market, he said he would prefer to see a buffer than a barrier for the downside protection.

“I like the European space quite a bit,” he said.

“I do believe there will be some restructuring, some influential changes in governments and some political pressures starting with Germany. We’re still wrestling with Brexit.”

Buffer preferred

At the same time, Medeiros said he was optimistic about the European market, especially given the European Central Bank’s “very accommodative” monetary policy.

“There’s a lot of potential for growth. With that in mind, I’m not a huge fan of barriers. The upside cap is fine. But this is an asset class that can be very volatile. What jumps out at me is the barrier. I would be more comfortable with a buffer.”

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Dec. 28.

The Cusip number is 61768K554.

© 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.