Morgan Stanley, GS Finance sell deeply protective notes on Russell, Nasdaq drawing comparisons

By Emma Trincal

New York, Dec. 15 – As fears of a recession are growing among investors, some issuers have brought defensive products that offer either principal-protection or ways to monetize returns in a bear market.

One example is Morgan Stanley Finance LLC’s $1.05 million of 0% equity-linked partial principal at risk securities due Dec. 11, 2025 linked to the Russell 2000 index.

If the index finishes at or above its initial level, the payout at maturity will be par plus the index return, capped at par plus 41.69%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index declines, investors will receive par plus the return of the index, subject to a minimum return of 90% of par.

A second example offered a sizable buffer with absolute return.

GS Finance Corp. priced $1.49 million of 0% buffered digital index-linked notes due Sept. 12, 2024 linked to the Nasdaq-100 index, according to a 424B2 filing with the SEC.

If the final level of the index is greater than or equal to its initial level, the payout at maturity will be par plus 11.75%.

If the index declines by up to 30%, the payout will be par plus the absolute value of the index return.

Otherwise, investors will lose 1% for every 1% that the index declines beyond 30%.

Cap and protection

“The Goldman Sachs one is really for bears. The cap gives you practically nothing on the upside,” said Steve Doucette, financial adviser at Proctor Financial.

“We don’t know if we’re going into a recession. But if the market leads us out of a recession, we might see a strong uptick. You would be missing the recovery. This note it too bearish. The cap is way too low and there is no leverage,” he said.

The Morgan Stanley notes offered more possibilities.

“At least it gives you a potential return of nearly 42%. Over three years, that’s not a bad return. I wouldn’t expect that type of return but you never know. If we go back in a bull market, you could very well be capped out,” he said.

The notes offered more downside protection than necessary, he said.

“OK, so you will get at least 90% of your principal back. That’s a loss limited to 10%. But over three years, I don’t think we could be down more than 10%,” he said.

Exposure

One advantage of the GS Finance note was the underlying index.

“The Russell 2000 has been down quite a bit. Its valuation is certainly more appealing than large-cap and tech stocks,” he said.

The Nasdaq-100 index dropped 31.6% from its Dec. 28 high a year ago.

The Russell 2000 index is trading 22.3% off its Jan. 4 peak.

Buffer preferred

Doucette said he would choose the Morgan Stanley notes but not before reshuffling the structure with an emphasis on enhancing the potential upside.

“I would get rid of the 90% protection. Instead of limiting my losses to 10%, I would put a 10% buffer in there.”

His priority would be to raise the cap.

“I might lever the upside a little bit and see where the cap falls. By giving up the 90% protection, it would be interesting to see what happens with the leverage and the cap.”

One advantage of shifting from a principal-protected structure to a buffered note would be the tax treatment, he said.

Holders of the principal-protected note are subject to an annual ordinary income tax they must pay even though they do not receive any income, according to the prospectus. In addition, the gains at maturity are also treated as ordinary income.

In contrast, the buffered notes receive capital gain or loss tax treatment at maturity, according to the prospectus for this note.

Reasonable cap

Matt Medeiros, president and chief executive of the Institute for Wealth Management, also preferred Morgan Stanley’s note.

“Looking at the GS Finance one, I’m not a fan of the cap. I don’t like the idea of being capped out on such a risky underlying at a coupon rate,” he said.

“I do like the absolute return component, but I’m probably not bearish enough to sacrifice so much upside for it.”

Medeiros compared the two underlying indexes.

“The Morgan Stanley is more appealing to me. The Russell 2000 is undervalued at the moment. You’re probably buying it at a good time,” he said.

“The 41.69% cap offered here is more in line with the index’s historical return. I think it’s reasonable.”

Downside protection

He compared the partial principal-protection with the protection granted by a buffer.

“The principal protection is pretty interesting. You’ll take the first 10% losses. But you wouldn’t buy this index without expecting a potential 10% downside anyway,” he said.

“A straight buffer is nice. But with the principal protection, your losses are capped at 10%, which is within the standard deviation of what you would expect for the Russell.

“If I know I can cap my loss at 10%, then I’m OK with it.”

Medeiros also liked the duration of the Morgan Stanley notes.

“I like the three-year better. In three years, you have enough time to move onto a new business cycle and recover from a downturn,” he said.

The Morgan Stanley Finance LLC notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61774TCU4) settled on Tuesday.

The fee is 1.375%.

Goldman Sachs Group, Inc. is the guarantor for the GS Finance notes.

Goldman Sachs & Co. LLC is the underwriter.

The notes (Cusip: 40057P2C5) settled on Monday.

The fee is 2.2%.

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