Morgan Stanley’s upside participation autocalls on Russell offer yield, unlimited upside

By Emma Trincal

New York, Jan. 27 – Morgan Stanley Finance LLC’s 0% autocallable securities with upside participation feature due Jan. 30, 2026 linked to the Russell 2000 index provide investors with cumulative income and a chance to participate in the upside at maturity, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus at least 8.55% per annum if the index closes at or above its initial value on an annual observation date other than the final one. The exact call premium will be set at pricing.

If the notes have not been called and the index finishes at or above its initial level, the payout at maturity will be par plus the greater of 25% and the index gain.

If the index finishes negative but greater than or equal to the threshold level, 75% of the initial price, the payout will be par. Otherwise, investors will lose 1% for every 1% that the index declines from its initial level.

Benefits of memory

“It’s a little different. But there are many moving parts,” a financial adviser said.

“I don’t have an issue with the issuer’s credit. But I’m not crazy about a five-year maturity.

“The idea of an 8.5% annual coupon is okay. But the chances for the small-cap index to be below its initial price is very unlikely. You will get called.”

The notes are known as snowballs, a type of autocallable note that pays investors a call premium upon the early redemption. The threshold for the call is at the initial price level.

Unlike typical autocallable contingent coupon notes, snowballs come with a “memory” feature. Missed payments are cumulative and can be recaptured upon a later call.

“That’s an advantage. But the disadvantage is you have to be positive to get the call and the premium,” he said.

“I’d rather own the ETF than play in the sandbox of an autocall.”

This adviser was relatively bullish on the underlying.

“The Russell will be up. Getting 8.5% is probably less than the historical average, which is in the neighborhood of 11% per year. Plus, you lose the dividend, which is about 5% over five years.”

Upside participation

The structure however offered something different from most snowballs, which is the participation at maturity in the event the notes never get called, he noted. A minimum payment of 25% is guaranteed if the index is flat or positive. Oddly, this adviser said, the 25% digital at maturity was lower than the call premium of 25.65% pocketed upon a call on the third year and even lower than the 34.2% payout on the fourth call date.

Still, the participation at maturity was intriguing.

“It’s an incentive to do the note because presumably you get the uncapped return,” he said.

“If the Russell has a quite modest performance at least you get 25%. It’s a nice feature assuming the Russell has a difficult five-year period.

Long tenor

A market participant said the term was too long and the barrier level too high.

“A 75% barrier is quite weak for a five-year. The risk is to never get a coupon because you have to be positive. If you don’t get called, you can lose a lot if there’s a downturn,” he noted.

“For me, a five-year is just way too long.

“In the past, you could do five-year notes with full principal-protection on an index. That’s real bond replacement. We did one in 2017. But those days are over. Current interest rates levels make it impossible. My point is: if extending the term doesn’t even give you a solid protection, I don’t see how it benefits you here.”

Secondary market valuations were another concern should noteholders decide to sell prior to maturity.

“You probably have a delta one to the downside,” he said.

“Market goes down 10% or 15%, the mark-to-market price of this product would go down pretty fast, probably down 10% to 15% too.”

Many buysiders find comfort in longer-dated notes based on back testing analysis showing that over longer periods, the chances of breaching a barrier are lower since there is enough time to recover from a bear market. This market participant disagreed.

“There is more risk over the long term. We may have finished a full cycle in five years, or we may not,” he said.

Fast money or else...

The autocall features of the note were satisfactory, he said. But the odds of participating in the upside at maturity were slim as well as the chances of accumulating the premium over time.

“The 8.5% coupon is fine. It’s tied to a single index, that’s fine too. The coupon has a memory feature. Fine. But to get the full amount at the end of the fourth year, you would have to have three years of downside. This is pretty path-dependent, and I’m not crazy about that,” he said.

“It’s like you don’t get called at the end of year one, end of year two, end of year three. And at the end of the fourth year, the index is suddenly positive so now you can collect your maximum return. Seems very unlikely. “The idea of being able to cash in at maturity doesn’t seem very likely either,” he said.

Market returns

“Either you get called early on or you suffer after five years.”

In today’s bull run, coupons paid by autocalls have a more difficult type to compete with: the market itself, he added.

“If you’re really bullish on the market, buy the index fund.

“You could get 8% perhaps in one month.

The Russell 2000 index has gained 6.16% in the past month and 36.2% in the last three.

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes were expected to price on Wednesday and will settle on Friday.

The Cusip number is 61771EN38.

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