Morgan Stanley’s dual directional notes on S&P 500 offer attractive jump, no cap

By Emma Trincal

New York, April 20 – Morgan Stanley Finance LLC plans to price 0% dual directional trigger jump securities due April 27, 2021 linked to the S&P 500 index, according to an FWP filing with the Securities and Exchange Commission.

The notes are guaranteed by Morgan Stanley.

If the index finishes above its initial level, the payout at maturity will be par plus the greater of the gain and the upside payment of 40%.

If the index falls but finishes at or above the 70% trigger level, the payout will be par plus the absolute value of the return.

Otherwise, investors will be fully exposed to any losses.

Term

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, said he liked the notes except for the term.

“Five-years is a long time for us,” he said.

At the same time, he said his firm was comfortable with the issuer’s credit.

Upside

By far, the appeal of the notes was the combination of a minimum return with an uncapped upside.

“This is an interesting note,” he said.

“We like the idea of a 40% coupon and that it’s uncapped. The idea that you get unlimited upside is very important to us because 40% over five years may not be as desirable if the stock has a nice surge.”

Barrier

The downside protection was valuable especially with the ability to generate gains if the index finishes down to 30% or less, he said. But given the choice, he would have preferred to see more return enhancement on the upside even if it meant altering the protection or the absolute return feature.

“The 30% downside protection is interesting but I don’t know how necessary it is,” he said.

Over any five-year period, he explained, the likelihood that the S&P 500 index would finish down by more than 30% was “very low.”

For those more concerned about market risk, the 30% level was not the best type of protection.

“It’s not a hard buffer. It’s just a barrier. If the index loses 31%, you’re down 31%,” he said.

The absolute return feature, he conceded, was attractive especially if the odds of breaching the barrier were limited based on historical returns.

Yet the index could also finish positive or mildly down causing investors to have overpaid for the downside.

Reengineering

“Rather than having that kind of protection, maybe I would prefer a modest buffer. In exchange, I would take either a higher digital on the upside with no cap or some leverage with the uncapped upside, somewhere around 1.2 or 1.5,” he said.

If having a 10% to 15% buffer translated into having to give up the absolute return, he would be willing to accept the tradeoff as long as he could secure either the higher minimum return or some leverage while keeping in both cases the upside uncapped.

As investors give up five years’ worth of dividends, which represents about 10% based on the benchmark’s 2% dividend yield, the issuer may have some leeway to reprice the structure, he added.

“Like any other structured note you don’t get the yield. But this is over five years so you’re definitely going to trail the index by 2% a year,” he said.

“For a long-term period you do want to have the ability to participate to the upside.”

Boost

The absence of a cap with a guaranteed return of approximately 8% a year was what made the structure stand out, others agreed.

“I’m a buyer,” said a portfolio manager and trader.

“They boost your return from zero to 40% and you take every penny over that.

“You don’t have to give up anything on the upside and if you’re wrong, you’re not penalized.

“It’s pretty easy to like.”

He shared with Foldes the view that the protection and absolute return component may not be as necessary as some may expect.

“Look, with the protection you’re going to sleep better. But if the market is down 30% you get bigger problems.”

Rather than expecting sharp gains or losses in five years, this trader said the market is likely to grow at a moderate pace.

Global headwinds

“With all the headwinds that we have, I don’t think we’re going to get 8% growth five years in a row,” he said.

“That’s when this 40% minimum comes into play.”

He pointed to “a lot of global headwinds” for the next five years.

“The U.S. is no longer creating a macro effect of its own. Now it’s much more global. In fact the Fed gets to take care of the whole world now.

“It will take at least two or three years for Europe to clean up their act.

“Germany is carrying all of Europe. Now they have to deal with this huge migrant crisis.

“China is slowing.”

As a result, this trader was not very bullish in his forecast for the S&P 500 index.

“Maybe single-digits for the next two or three years and maybe lower double-digit after that.

“That’s why this payout is pretty neat.”

Morgan Stanley & Co. LLC is the agent.

The notes will price on April 22.

The Cusip number is 61766BAN1.

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