Morgan Stanley’s $1 million trigger jump notes on Russell 2000 aimed at risk-averse investors

By Emma Trincal

New York, June 23 – Morgan Stanley Finance LLC’s $1 million of 0% trigger jump securities due June 17, 2032 linked to the Russell 2000 index contrast with most products with its long duration and solid downside protection, advisers said.

Noteholders are guaranteed a minimum return of par plus the greater of the index return and 88.5% if the index finishes positive.

Investors will receive par if the index declines but finishes at or above the trigger level, 50% of the initial level, and will lose 1% for every 1% that the index declines if it finishes below the trigger level.

Risk aversion

“Interesting that over the last 10 years, the annualized compounded return of the Russell 2000 has been 7.8%. This note pays as a minimum return 6.5% on a compounded basis. That’s not so bad given that we had an unusually strong 10 years except for the past couple of months,” said Jeff Pietsch, founder of Capital Advisors 360.

The structure of the note showed a strong defensive tilt given the size of the barrier, he added.

“After a significant drawdown – the Russell is down more than 25% this year, you’re getting another 50% in barrier protection. That’s playing it relatively safe. You would have to be basically 75% down from the highs before incurring a loss,” he said.

“Only an investor with an extremely adverse relationship with volatility would want to purchase this structure.”

Some drawbacks

Pietsch said a buyer of the notes would share some of the risk profile characteristics of a bond investor.

“You’re not getting any income for a long time, so it’s not a fixed-income equivalent per se. But your downside risk is fairly low, so low that it’s somewhat close to the risk profile of a fixed-income instrument,” he said.

“It gives you an opportunity to participate in equity returns with a very high chance of getting 6.5% a year and a very limited downside risk.”

However, investing in the notes also had its shortcomings.

“There are a few negative aspects to this product, starting with the very long holding period. While you can always try and sell a structured note on the secondary market, your liquidity remains limited, and 10 years is a long time,” he said.

“You’re also giving up 1% in dividend payments over 10 years.

“There is the drag of a 3.35% fee, which you pay upfront,” he added referring to the commission amount disclosed in the prospectus.

“Finally, you have the counterparty risk exposure for 10 years. Not that I would be too concerned about Morgan Stanley going bankrupt in the next 10 years. But you’re not getting paid the yield on Morgan Stanley’s corporate paper.”

Suitability

Other potential types of clients interested in the note would be those nearing retirement, he said.

“If you only have a few years before retirement, your tolerance for risk is going to be limited. In that case, the notes would make sense. You could use it in a target-date equity allocation,” he said.

Target-date funds and portfolios are designed to become increasingly conservative as investors get closer to retirement.

“But for anyone between the ages of 20 and 40, I don’t really see the point of buying this note. The Russell is going to be higher over time, especially from where we are. If you’re a younger investor it would only be suitable if you have an extreme aversion for risk,” he said.

In both situations – being near retirement age and/or having a low risk tolerance, the notes may serve a purpose, he concluded.

“It allows you to enhance your long-term yield by getting equity-type participation over a very long timeframe without incurring the historic risk level associated with equities,” he said.

Good bet

Another financial adviser said the notes could be useful to a wide range of investors as long as they have a long-term horizon.

“For the long-term portion of your portfolio, you’re getting a minimum return of about 7% a year.

“If you want long-term exposure to the Russell, this is an excellent bet.

“The 50% is probably not needed. But everything works perfectly until it doesn’t.

“Even on a 10-year, I’d be happy to have that level of protection. And keep in mind that by getting that barrier, you’re not losing the upside.

“It’s a great way to have capital preservation and full upside participation,” the financial adviser said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on June 17.

The Cusip number is 61774DQU4.

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