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Published on 4/23/2009 in the Prospect News Structured Products Daily.

Morgan Stanley links lookback notes to S&P 500; features work for a recovery, adviser says

By Kenneth Lim

Boston, April 23 - Morgan Stanley's planned accelerated notes with a lookback entry feature could be an attractive investment for investors who are bullish about the underlying index, an investment adviser said.

Morgan Stanley plans to price zero-coupon Lookback Entry Performance Leveraged Upside Securities (PLUS) due April 29, 2011 linked to the S&P 500 index.

The initial index level will be set at the lowest index closing value between the pricing date and June 22, 2009.

At maturity, investors will receive par plus double any gain in the index, subject to a maximum total payout of 136% to 141% of the principal. Investors will lose 1% for every 1% decline in the index. The exact cap will be set at pricing.

Recovery-friendly features

The product has a number of features that would work well if the S&P 500 is bottoming, the adviser said.

"Upside leverage tends to work well in recoveries because recoveries are usually on a gentle gradient, and the leverage allows you to make the most of a small market improvement," the adviser said.

"Of course, when the market is doing really well, having upside leverage is great also, but when the growth is faster there's a higher risk that you'll pass the cap, so there's that additional factor to consider."

The lookback entry feature would be particularly enticing for investors who think that the market could be turning around soon, the adviser said.

"They're basically giving you the best-case scenario in the first two months, which is great if you think that the downturn is coming to an end because this allows you to position your base as close to the bottom as possible within those first two months," the adviser said. "If you think the market's going to turnaround, that's a great feature to have."

But the feature will also help investors whether the market eventually goes up or down, the adviser noted.

"Even if the index is down at maturity, you could potentially take some of the pain away because of this," the adviser said. "The only instance it won't work is if the index keeps going up in the first two months, then your initial level is just the starting level, which means that it basically had no effect."

Little room for error

But the lack of downside protection could hurt investors who make the wrong call, the adviser said.

"If the index doesn't make a recovery, you have no downside protection," the adviser said. "So if you buy this you have to be really confident that the index is going to go up at the end of two years. There's no buffer to cushion the loss."

The product could also be difficult to value at the start, the adviser said.

"One problem for some advisers could be trying to value this at the start," the adviser said. "You don't know where the starting point is until June 22, so how do you account for that? You'll have to figure something out and then explain it to your client. On paper it looks like a really neat feature, in practice it's a little more complicated. But I think it's interesting enough that some people be willing to work around that."


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