Morgan Stanley’s $12.5 million 9.15% trigger callable notes on ETFs designed for cautious play

By Emma Trincal

New York, Sept. 20 – Morgan Stanley Finance LLC’s $12.5 million of 9.15% trigger callable yield notes due Dec. 21, 2023 linked to the least performing of the iShares Russell 2000 ETF and the SPDR S&P 500 ETF Trust may appeal to conservative investors due to a double set of safety: a guaranteed coupon payment and a deep barrier at maturity, advisers said. The only downside may be the potentially short life of the notes due to the issuer’s discretion to call them as early as in December.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are callable at par on any coupon payment date after three months.

The payout at maturity will be par unless the least-performing ETF finishes below its 60% downside threshold level, in which case investors will lose 1% for each 1% decline of the least-performing ETF from its initial level.

Fee, term

“This is an interesting note. We haven’t seen anything specifically like this before. Most coupons are market-dependent,” said Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management.

“It’s a nice short-term note and we do like short-dated notes,” he said.

One caveat was the 1% fee, as disclosed in the prospectus.

“It’s a little bit on the high side for a short note like this, which could potentially be shorter,” he said alluding to the call.

Worst-of, barrier

But Foldes said he liked many other features.

“The worst-of between the S&P and the Russell is a good worst-of because those two typically have a very high correlation. They move in tandem with each other,” he said.

“The fixed interest rate of 9.15% a year is really nice. Even with interest rates rising, it’s a pretty good return.”

Foldes also liked the 60% principal repayment barrier at maturity.

“Given that both the S&P and the Russell are already down 20% for the year, that 40% barrier gives you some solid amount of protection. A decline of 40% from where we are now would be a historical decline, at least in Post-World War II,” he said.

Issuer call

Foldes said he only had two issues with the notes, first its cost, but more significantly, the issuer call.

“What bothers me a little is that there is no strict formula for the call. We know the note will not be called for the first three months so you will get your 2.28%. But after that, they can call it anytime on any given month. I would prefer to see stricter guidelines because for investors, that’s a lot of uncertainty to deal with,” he said.

“You can’t tell the client if it’s a three-month or a 15-month note.”

An early call may also be a problem for the adviser who spends time doing research to find an income-oriented note.

“It gets called in three months and you have to do it all over again,” he said.

Foldes disputed the idea that a 2.2875% return over three months was the same as a 9.15% gain in one year.

“Mathematically it is the same thing. But from the client’s perspective there is a difference, which is real money,” he said.

“A lot of the terms are very attractive in this note. But this issuer call after three months is a non-starter for us.”

Guaranteed income

A financial adviser said he could use the notes for risk-averse clients.

“It’s a lot shorter than what we tend to buy because we like to encourage our clients to hold securities as opposed to be jumping in and jumping out,” this adviser said.

However, the 9.15% rate of return offered regardless of the market direction was the key benefit of the notes, he added.

“9.15% is a pretty good chunk of change relative to existing interest rates. It’s very close to my target for equity-like investments,” he said.

Not exactly a bond

The temptation of comparing the notes to a bond was high due to the defensive barrier. But he said he would not use the notes as a bond equivalent simply because the equity risk exposure was still there.

“It’s a little bit bond-like because the likelihood of breaching the 60% barrier is so small. But still, I couldn’t call it a bond. You can still lose some principal due to the market,” he said.

Previous bear markets have shown big drawdowns, he noted.

The 17-month bear market from Oct. 9, 2007 to March 9, 2009, which saw the S&P 500 index drop 56.8%, was an example.

“These are very big losses. But honestly, I don’t see another 2007-09 and certainly not within a 15-month window,” he said.

Limited downside risk

He examined data going back 70 years for the S&P 500 index and 35 years for the Russell 2000 index.

“Statistically, if you look at 15-month rolling periods, the probability for the S&P to drop more than 40% is only 0.5% and for the Russell it’s 1.1%,” he said.

“So yes, this 60% barrier could be breached. But you can’t develop an investment philosophy on what could happen. What I’m focusing on is the likelihood of it.”

Confidence builder

This adviser said the notes could be useful for investors who lack confidence for fear of losing money in the stock market, those who have remained overweight cash as a result of those fears.

“I may fund this out of cash.

“Some clients are too nervous to invest in equities. They sit on the sidelines, which is not good because when you do, you always miss the rebound. This would be a good way to give those risk-averse investors an incentive to go back in. They can get a 9% return and take the risk out of the equation.”

The notes are guaranteed by Morgan Stanley.

UBS Financial Services Inc. and Morgan Stanley & Co. Inc. are the agents.

The notes settled on Tuesday.

The Cusip number is 61774E527.

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