Morgan Stanley’s $20.68 million leveraged buffered notes on S&P 500 to fit mildly bullish view

By Emma Trincal

New York, Sept. 16 – Morgan Stanley Finance LLC’s $20.68 million of 0% leveraged buffered index-linked notes due Dec. 21, 2023 tied to the S&P 500 index allow investors with modest return expectations for the next 27 months to possibly outperform the market, an adviser said.

If the index return is positive, the payout at maturity will be par plus 1.1 times the index gain, subject to a maximum return of par plus 28.05%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 12.5% and will lose 1.1429% for every 1% that the index declines beyond the 12.5% buffer.

Outperformance

“The cap is generous. When you can get close to a 12% annual return, nobody is going to complain about it,” said Steve Doucette, financial adviser at Proctor Financial.

The 28.05% maximum gain over the term of the notes is the equivalent of an 11.62% annualized compounded return.

“It gives you a little bit of leverage. It’s not a lot, but you can still outperform by 1%.

“You can also outperform all the way down. This thing is geared but it’s going to take a while before the buffer becomes useless.

“Either way you’re going to beat the market unless you believe it’s going to be higher than 12%,” he said.

Doucette said he did not expect this to be the case.

“We’re at a market peak. I’m pretty confident the capping is sufficient,” he said.

The S&P 500 index hit an all-time high on Sept. 2 at 4,545.85 and has nearly doubled in the past 18 months.

More leverage

“If I had to redo the note, I would probably want to increase the leverage a little bit. Do I really expect a 28% return in 27 months? If I expect less, how much more leverage could I get?

“That would be the type of conversation I would have with the issuer,” he said.

But Doucette would leave the buffer as is.

“Many people like the additional protection you get from a barrier. If you changed this buffer into a barrier, you may get perhaps 30% or 35%. But if you burst through the barrier, you’re long the index. You no longer outperform in this scenario.

“Granted the gearing theoretically could wipe out 100% of your principal. But it would take a lot to chew up that,” he said.

The 1.1429 multiple is the quotient of the initial level divided by the buffer level of 87.5%. As a result, investors are not guaranteed 12.5% of their principal at maturity as they would be with a traditional buffer. Instead, 100% of their principal is at risk.

Speculative bet

Tony Romero, co-founder and chief executive of Suncoast Capital Group, whose firm specializes in the sales of brokered CDs, said the trade was too risky.

“I wouldn’t want to bet that the S&P won’t go down more than 12% in the next 27 months. The index could have a lot of movements up and down between now and then,” he said.

He looked at the potential outcomes on the downside and the upside.

“You do have that limited protection. If the index is down 30%, you’ll lose 20%. It’s a better scenario than owning the index.

“But at the same time, if the S&P is up more than 11.62% a year, you lose,” he said.

Romero was not particularly comfortable with the point-to-point observation.

“The performance is only observed once, at maturity. It’s not as if you had a weighted average every month,” he said.

Headwinds

“Personally, I think there’s a 50/50 chance the index will be lower especially with the emergence of new geopolitical developments. The Fed could also stop their support and begin tapering.

“Of course, the S&P could drop 20% next year and go back up 30% the next year. But it’s pure speculation to imagine that the market won’t drop more than 12.5% 27 months from now.”

The near future is likely to be even more uncertain with the U.S. Congress Elections coming up in November 2022, he noted.

“The results of these elections will determine the nature of the public policies that will be adopted, and policies affect the index.

“If I wanted to speculate in equities, I would buy the index directly. I don’t need a fixed income product to do that.

“I would just buy or sell the ETF,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61773FXS7) will settle on Friday.

The fee is 0%.

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