Morgan Stanley’s $34.4 million buffered jump notes on S&P 500 to outperform in sluggish market

By Emma Trincal

New York, April 2 – Morgan Stanley Finance LLC’s $34.4 million of 0% buffered jump securities due April 1, 2027 linked to the S&P 500 index give investors a chance to beat the index in a flattish or moderately bullish environment while a hard buffer will protect some of the downside. But one adviser wished the digital return had been higher.

If the index finishes above its initial level, the payout at maturity will be par plus 26.72%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index finishes below its initial level but declines by 17% or less and will lose 1% for every 1% that the index declines beyond the buffer.

Big deal

Tom Balcom, founder of 1650 Wealth Management, said the notes may be appropriate for conservative investors.

“You take the equity exposure that offers you more than the risk-free rate while getting a 17% downside protection. You’ll gain 8.2% a year on a compounded basis versus 4.5% on the three-year Treasury,” he said.

“That’s almost four points over. But the equity-like return is not huge. I’d definitely want more upside.”

He noticed the popularity of the offer.

“It’s a good size deal. It was probably done by a large [registered investment adviser],” he said.

Three purposes

Balcom said he was not sure what the dominant rationale would be behind this one.

“When you look at these structured notes in general, the question is always: what’s the thesis behind the deal? Given the large buffer here, it was possibly done to reduce risk, meaning to hedge some part of the portfolio,” he said.

“Personnally, I would take a smaller buffer to get a little bit more upside because clients will always compare their return with the performance of the S&P.”

Another possible objective may be to outperform the market.

“We had a nice run. If the market is just flat in three years, you’ll outperform with less risk,” he said.

Finally using the note as a fixed-income replacement could be a third option for some. But not for Balcom who said that despite the buffer, investors still had equity exposure and could lose up to 83% of their principal.

Low digital

“I guess I’m not really sure how I would position the note in the portfolio. The way it is structured with the 17% buffer looks like it’s more of a hedging play.”

And while Balcom routinely uses notes for hedging purposes, this one would not fit in his portfolio.

“I would tend to prefer a double-digit return. If the clients like the numbers, we would reduce the buffer size a little bit. But the 8% a year cap even for a digital is a little bit too small for my taste.”

Downside protection

A financial adviser said the note was designed for mildly bullish investors with modest return expectations.

“The good thing about it is the simple payout. You don’t have to do math. If it’s up, you get 26.7%. If it’s down, you’re protected on the first 17%,” he said.

“That 17% is likely to cover you over a three-year period.”

The size of the buffer gave the notes a defensive profile. There was some “risk” on the upside.

Mild bulls

“If the market rises 12% a year and you only make 8%, you would be missing a third of the return.”

This possible “opportunity cost” was the price to pay for the protection on the downside and the possible alpha on the upside if the market moved slightly higher or stayed flat.

“This is a vehicle for people who have very low return expectations for the next three years and want some downside protection,” he said.

“I like the fact that it’s a straightforward note. It’s easy to understand and easy to explain.”

Reasons to worry

Investors in the notes are likely to have a cautious approach to the market, he added.

“The market has run up considerably over the past several months. It makes sense to be a little bit defensive,” he said.

“Investors are quick to react when the Fed signals that they are not going to cut rates as quickly as they had anticipated. Investors got ahead of themselves as to when they expected the Fed to push rates lower. People are now recalibrating their expectations. The result is we’re likely to see more volatility.”

The Dow Jones industrial average dropped nearly 400 points on Tuesday on inflation fears and the market pricing fewer rate cuts.

For investors who would be right to be cautious, the notes may have a lot to offer, he said.

“Volatility picks up, the market is down, recovers some and finishes flat in three years. You’re going to get 26.7% instead of next to nothing,” he said.

“That’s a desirable outcome.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on March 27.

The Cusip number is 61776LBZ9.

The fee 0.25%.

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