Morgan Stanley’s $1.88 million trigger gears on S&P 500 are too long to pitch, adviser says

By Emma Trincal

New York, May 16 – Morgan Stanley Finance LLC’s $1.88 million of 0% trigger gears due May 17, 2033 linked to the S&P 500 index was unusual as a 10-year bullet note, especially in the equity derivatives space, an adviser noted. While the terms were attractive, such long tenors may be rare for a reason, he said, as very few investors would be willing to tie up their money for so long.

If the index return is positive, the payout at maturity will be par plus 1.51 times the index return, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the return of the index is at or below its initial level but ends at or above the 65% downside threshold and will lose 1% for every 1% decline if it ends below the downside threshold.

Unusually long

“I have never seen a 10-year note on equity. No cap, of course. If there was one, I would have a problem with that,” said a financial adviser.

“The S&P is my favorite index, so this is fine. Plus, it’s only on the S&P. There is no worst-of to worry about.”

One downside is the non-payment of dividends over the 10-year period, he noted. The S&P 500 index pays a 1.7% dividend yield.

Dividend ‘loss’

“You’re losing the dividends. But with 1.5x leverage, you can make up for it, at least at some point,” he said.

On a compounded basis, the dividends would return about 18% over the period.

“You’re not going to outperform immediately. You need to get a certain amount of return to make up for the loss of dividends, just because 10 years is such a long period of time,” he said.

For instance, an investment in the ETF with a price return of 20% would generate a 38% total return in 10 years. But noteholders, even with the leverage, would only pocket a 30% gain.

“Same thing on the downside. If the index is down slightly, the return on the note will trail the index fund.”

65% barrier

Another important question was to assess the strength of the barrier.

“I found a very, very low probability of breaching this 65% barrier over the 10-year timeframe,” he said.

He based his conclusion on back-testing analysis having collected 70 years’ worth of data on the S&P 500 index performance. Using a 10-year rolling period, he found that the 65% barrier was knocked out only 0.4% of the time.

Those instances occurred during a turbulent decade between March 1999 and March 2009 when the index went through two bear markets, he added.

“The only way this note is going to breach the barrier is if we go from all-time highs to levels that are ridiculously low. There is an argument for that as many people say we’re at the brink of a recession. But the S&P already hit an all-time high in January of last year and from that point, it dropped about 25% hitting a low in October.

“Since then, we have partially recovered. But even now, we’re significantly off the all-time high,” he said.

Tough sale

The only drawback for this adviser was the long tenor.

“My problem with this note is the longevity. Ten years is a very long time. In 10 years, we will have had three Presidential Elections. Most people shy away from long-term commitments whether it’s a 10-year structured note or a private equity investment. I think investors would rather buy farmland, which is also a long-term commitment. But at least it’s tangible. You know it’s going to be there 10 years from now,” he said.

Credit risk

This led him to bring up the issue of credit risk.

“Now that we just had a banking crisis, you have to worry about that too,” he said.

“Even though Morgan Stanley is a solid bank, the possibility that they may not be around in 10 years is a bigger risk to me than the market risk.

“It’s a great note. But I would get pushed back by my clients. If you’re 65 or 70 years old, you’re not going to be interested in a 10-year note.

“It would be a tough pitch.”

Bad timing

A buysider said he did not like the notes but not because of their length.

“I’m not a big fan of going long U.S. equity at the moment,” he said.

“Even if a 10 year may offer a better chance to get your money back, it’s not a guarantee. The market can still be lower. The S&P is so high right now, it could easily go down, come back a lot but not as much as needed to get you back to even.”

He offered an example: if the S&P 500 index was to lose two-thirds of its value, it would have to triple in order to fully recover, he said.

“How often have we seen that type of recovery? It can happen sometimes. But it’s rare,” he said.

The market more than doubled between March 2020 and January 2022. But such a rebound was unusual, he noted.

After the dot.com crash of March 2000, the S&P 500 index briefly returned to its previous high in October 2007, but did not stay there very long as the 2008-09 bear market was just at the corner.

“You had to wait until 2013 to see the S&P 500 index really recovering,” he said.

Playing it safe

This buysider said that safer alternatives are available to investors.

“I would much rather invest in government bonds in this uncertain market. I-bonds are yielding 4.3% right now and they protect you against inflation. Short-term Treasuries are very attractive and safe. You can get 13- to 26-week Treasuries yielding over 5%.

“In 10 years, you could earn a 65% return with a bond yielding 5%. If I had to go long-term, I would much rather buy Treasuries, which are risk-free,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent, and UBS Financial Services Inc. is acting as dealer.

The notes will settle on Wednesday.

The Cusip number is 61774W378.

The fee is 5%.

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