Morgan Stanley’s, RBC’s leveraged notes on Euro Stoxx to be used in small, speculative bet

By Emma Trincal

New York, Sept. 8 – Morgan Stanley and RBC respectively priced issues of leveraged uncapped notes tied to the Euro Stoxx 50 index, one with a 20% buffer, the other with an 80% barrier. As they discussed the risks associated with the region, advisers picked their preferred offering mainly based on the nature of the downside protection. Both agreed that investing in the index was a risky bet requiring a limited allocation.

Morgan Stanley Finance LLC priced $3.06 million of 0% Trigger PLUS due Sept. 3, 2026 linked to the Euro Stoxx 50 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is positive, the payout at maturity will be par plus 208% of the index return.

Investors will receive par if the index return is negative but ends at or above the 80% trigger and will lose 1% for every 1% decline if it ends below the trigger level.

Separately, Royal Bank of Canada priced $5.73 million of 0% Leveraged Index Return Notes due Sept. 24, 2027 linked to the Euro Stoxx 50 index, according to a 424B2 filed with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus 161% of any index gain.

If the index falls by up to 20%, the payout will be par. Otherwise, investors will lose 1% for every 1% decline beyond 20%.

Looking upward

“Where we are in this market, I don’t know that you need a 20% buffer,” said Steve Doucette, financial adviser at Proctor Financial, about the RBC deal.

“Do you expect the Euro Stoxx to be down more than 20% in five years? That’s a five-year bear.

“I’m not too sure the buffer is adding much value.”

The longer tenors of those two notes made this adviser more bullish than he would be over the short term.

“Four to five years out, I want more potential for the upside,” he said.

“If it’s going to go down short term, which it probably will, four or five years from now, it’s going to be on the way back and you should get a decent return especially with the uncapped leverage.”

Since he assigned less value to the buffer and more interest in generating higher gains during the period, Doucette said he would seek to maximize the upside leverage.

“I lean toward the excess leverage – 2.1x rather than 1.6x – and the shorter tenor. Four years is shorter, but not by a lot and it still gives you plenty of time to recover from a bear market,” he said.

Laggard index

One characteristic of European stocks, he noted, is the way they are lagging the U.S. markets.

“If you believe in mean reversion as I do, it’s worth exploring this asset class although you need some patience because the Euro Stoxx has underperformed the U.S. for some time,” he said.

The SPDR Euro Stoxx 50 ETF, which replicates the index, has produced lower annual returns than the SPDR S&P 500 ETF eight years out of 10 between 2012 to 2021, according to data compiled from Morningstar.

The average gap has been nine percentage points per year.

The Euro Stoxx outperformed the U.S. benchmark only twice during that period – in 2012 and 2017 by 4.64% and 2.7%, respectively. For this year through Sept. 2, the Euro Stoxx ETF is already underperforming the SPDR S&P 500 fund by 10 percentage points.

“All global indices are falling right now. But what’s really strange is the fact that Europe has not outperformed the U.S. for a very long time. That trend seems to continue,” he said.

Doucette said he still considers investing in Europe given its attractive valuations.

“Emerging markets was a mess in the late 1990s. But between 2003 and 2007, they outperformed the U.S. I’m still a strong believer in reversion to the mean even though a number of things have changed since Covid,” he said.

Leverage, tenor

One of the attractive terms common to both notes was the leverage without a cap.

By choosing the barrier note, Doucette was getting slightly more upside leverage.

“Having no cap and a decent amount of leverage four years out, that’s where you want to be,” he said.

Doucette said he also preferred the slightly shorter tenor –four versus five years.

“We like to keep it to three to four years, especially with these growth notes, so the four year is actually better,” he said.

Before considering buying any of the two notes, Doucette said he would have to do some due diligence.

“These notes are part of your asset allocation. You have to assess the risk-reward of this particular asset class,” he said.

“Europe is going through a tough time between the war in Ukraine, the inflation and the energy crisis.

“Energy is only 6% of the portfolio. It’s actually a pretty well-diversified index,” he said.

The top three sectors in the index are consumer discretionary with a 20.7% weight, followed by financials with a 14.1% weight and technology with a 13.8% weight.”

“You’d have to look at it more closely and see how you want to park your money for four or five years. It’s a nice growth play on an underperforming asset class. But I would keep it small,” he said.

Buffer, a must

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more inclined to play defense.

“If I have the choice based on two very similar products, most of the time I’m going to prefer the buffered one, especially with a market like Europe, which is facing a number of headwinds. You don’t want to add more uncertainty with a barrier.

“So, I would certainly be in favor of the five-year note with the buffer.”

Medeiros said he also liked the longer tenor of the buffered note.

“There is less risk if you go longer, no question about it. So, the four-year note presents another disadvantage in addition to the barrier,” he said.

Europe had become over recent years a more volatile market for investors, he noted.

“The current challenges in this part of the world are the war, which hopefully is not escalating, and the energy crisis. Both are intertwined and could impede economic growth in Europe,” he said.

Speculative bet

The Euro Stoxx 50 index has dropped more than 23% from its November peak to a July low. The index’s price appreciation has been modest since.

“The risk is priced in the valuation of the index. You’re getting a deep discount to the U.S market,” he said.

“On the other hand, I don’t see European equity outperforming the U.S. in the near term. Whether it may outperform by the end of the four/five-year period, I couldn’t tell.

“Part of the problem is that it’s hard to imagine what could be the catalyst for Europe to turn around.”

Despite the uncertainty attached to Europe at this time, this adviser said the structure of the buffered note was relatively appealing for its uncapped leveraged return, long duration but mostly its large buffer.

“I would be interested in a note like this, but if I bought it, it would be for a speculative allocation, and I would only allocate a small size to it,” he said.

The Morgan Stanley deal settled on Tuesday.

Morgan Stanley & Co. LLC is the agent, and Morgan Stanley is the guarantor.

The Cusip number is 61774B887, and the fee is 3%.

The RBC deal (Cusip: 78015B351) will settle on Friday.

BofA Securities, Inc. is the agent.

The fee is 2.5%.

© 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.