Morgan Stanley’s contingent income autocalls on ARK Innovation ETF tap into recent ‘hot’ trend

By Emma Trincal

New York, Feb. 10 – Morgan Stanley Finance LLC’s 0% autocallable contingent interest notes due Aug. 26, 2022 linked to the ARK Innovation ETF provide exposure to a portfolio of companies thriving in “disruptive innovation” targeting investors seeking income out of a strong growth portfolio, sources said.

The notes pay a contingent monthly coupon at an annual rate of 13% if the fund closes at or above its 60% coupon barrier on the review date for that month, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the fund closes at or above its initial level on any monthly review date after six months.

The payout at maturity will be par plus the coupon unless the fund finishes below its 60% barrier level, in which case investors will be exposed to the fund’s decline from its initial level.

Big gains

The ARK fund is an actively managed ETF consisting of stocks of companies deemed to be introducing “disruptive innovation” through technology either via the distribution of a new product or a new service.

Its eye-popping performance has caught the attention of portfolio managers and recently of structured notes issuers.

The ARK Innovation ETF has a five-star rating from Morningstar. The fund is up nearly 13% in the past month and has gained no less than 152% over the past year. Its annualized return since inception in 2014 is 36.4%.

Growing interest

“It’s a hot underlying right now. We’ve been selling a lot of them, especially since the end of last year,” a sellsider said.

Citigroup Global Markets Holdings Inc.’s $1.35 million of three-year autocallable contingent coupon notes was the first U.S. registered deal to be priced on the ARK Innovation ETF on Dec. 22, according to Prospect News, which tracks notes registered with the SEC.

Telsa Inc. with a nearly 11% weight is the top holding in the fund’s portfolio followed by Roku Inc. (5.28%) and CRISPR Therapeutics AG (5.54%), a gene-editing company, according to the fund’s investment management firm, ARK Investment Management LLC.

Chief executive Cathie Wood runs other alternative investment funds focusing on innovation in other niche areas such as genomic revolution, 3D Printing and space exploration.

The ARK Innovation ETF is the broadest.

So far $43 million of notes tied to the ARK Innovation ETF have been brought to market, according to data.

Other issues include worst-of deals combining the ARK Innovation with other ARK funds such as the ARK Genomic Revolution ETF and the ARK Next Generation Internet.

Monetizing growth

“If you have a significant downside protection like 60% here, that can be a great way to get income in a tactical portfolio,” the sellsider said.

Having more than 10% of its assets in Tesla, the fund can potentially dramatically move in either direction of the market. Its implied volatility is 45.39%.

Risk cannot be overlooked.

“A barrier can always be breached. But this being an actively managed ETF, you have a little bit more of a safety net,” he said.

The automatic call is always a risk-reducing feature as well.

In this case, the six-month call protection provided a beneficial feature to yield-seekers.

“Knowing that you have the potential to earn 6.5% in six months and that you’re not going to get called after a month is appealing for a lot of investors,” he said.

Since the first Citi deal, JPMorgan Chase Financial Co. LLC and Morgan Stanley have priced more of those ARK deals. On the first business day of the year, UBS AG, London Branch settled a $10 million deal on the ARK Innovation.

“It’s growing. The appetite for those forward-looking tech companies all concentrated in an actively managed portfolio is reflective of the growth of ARK’s assets under management. I see more and more issuers looking to price more deals on these ARK ETFs,” the sellsider said.

Risk-reward

Many biotech and technology stocks are richly valued and prone to corrections, a market participant said.

“But it’s not like buying the shares. You have a barrier. Now if you think the barrier can be breached, then don’t buy the notes,” he said.

Some clients may object to buying a structured note paying a 13% annual contingent rate when the ETF posted a 13% gain in the past 30 days.

“Look, you have to be happy with 13% a year. The fund was up 13% last month, but who knows what it’s going to be next month? This type of growth may not be sustainable. If you’re really bullish, don’t buy the notes, buy the ETF,” he said.

Investors in the notes are not chasing high returns, he added.

“This is not a growth investment. This is for people who want a return that’s easily achievable, as long as the barrier conditions are met. It’s an autocall. The fund doesn’t even have to go up. It can go down 40% and you’ll still get your 13% income.

“I think it’s a fair deal,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Feb. 23 and settle on Feb. 26.

The Cusip number is 61771EM54.

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