Morgan Stanley’s buffered PLUS linked to VanEck Vectors Oil Services ETF target strong bulls

By Emma Trincal

New York, Aug. 19 – Morgan Stanley Finance LLC’s 0% buffered Performance Leveraged Upside Securities due Feb. 22, 2019 linked to the VanEck Vectors Oil Services ETF offer a “big cap” and “fair” leverage, making the notes mostly aimed at aggressively bullish investors with a high tolerance for risk as the underlying fund’s high volatility increases the risk significantly despite the buffer, said Tim Vile, structured products analyst at Future Value Consultants.

The notes will be guaranteed by Morgan Stanley, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 133% of any fund gain, up to a maximum return of 53.2%. Investors will receive par if the fund falls by up to 20% and will lose 1.25% for each 1% decline beyond 20%.

Strong growth

“This gives you a decent amount of leverage but more importantly a pretty high cap,” said Vile.

Investors need to see the ETF share price increase by 40% over the two-and-a-half-year period in order to reach the 53.2% cap, he noted.

“It’s a pretty ambitious return. This note is really for strongly bullish investors.”

Bulls with less conviction tend to use high leverage to hit a cap, which can be low, based on modest performance expectations.

“This note offers an attractive upside potential,” he said.

At the same time, the amount of protection seems high for this type of investor, he noted.

“A very bullish investor would have probably settled for less protection on the downside in order to increase the potential return,” he said.

“If you’re that bullish, you’d want a higher cap even though this one looks good as it is,” he said.

Oil ETF

The VanEck Vectors Oil Services is an equity fund with wide price fluctuations, he said.

The annualized compounded return offered by the notes is about 18.5%. The implied volatility of the underlying is 29%.

“This is a very volatile fund. You could easily miss on the returns,” he said.

The share price rose 45% from the beginning of the year through early June. During the two following months, it dropped 13%. Since the beginning of August, the share price has already gained 10%.

Geared buffer

“Even though you have a 20% buffer on the downside, the big price moves seen with this fund can easily take you below 80%. Then things can go bad,” he said.

The gearing on the downside puts investors at risk of losing 100% of their capital, according to the prospectus. No minimum payment is guaranteed at maturity.

“If the price drops a lot, the gearing can compound your losses rather quickly,” he said.

This level of risk is illustrated by Future Value Consultants’ research report.

The company evaluates risk with its riskmap, a score the represents the sum of two risk components, market risk and credit risk. All scores are measured on a scale of zero to 10 with 10 as the maximum risk possible.

Market risk

The notes have a 5.83 market riskmap versus an average of 1.75 for the same product type, according to the report.

“This is why the level of protection alone doesn’t give you the full story. A 20% buffer looks great initially. But when you include a volatile underlying like this one, one that’s directly correlated to the price of oil, you get a high level of risk,” he said.

The report compares the product with its peers in the “same product type” group, which in this case is leveraged return. The firm also compares the notes to all products.

Credit risk

The credit riskmap is 0.53, slightly over the 0.46 average for the leveraged return category, according to the report.

“You get exposed to the issuer’s credit risk for two and a half years, that’s one thing – although for that structure type, it’s not that long,” he said.

Another factor is the issuer’s credit default swap rates, seen as wider than the average U.S. bank at the present.

Morgan Stanley’s CDS spreads are at 91 basis points versus 75 bps for both Bank of America and Citigroup, 61 bps for JPMorgan and 50 bps for Wells Fargo, according to Markit. Goldman Sachs has slightly wider spreads than Morgan Stanley at 95 bps.

When adding the two components, the riskmap is 6.37, compared to the average of 2.21 for similar products and 2.17 for all products.

“It is a high-risk product. It’s mainly because we have this very volatile underlying asset. A regular buffer or a lower threshold would have reduced the riskmap,” he said.

Return

To measure the risk-adjusted return of a product, Future Value Consultants generates a return score on a scale of zero to 10. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The return score is 6.04 versus an average of 7.45 for similar products and 7.14 for all products, the report showed.

“The high risk is one factor,” he said.

“The other reason is the cap. Even if it’s a high cap, it still limits your upside.

“Finally the high cap may not be so easy to reach. The index needs to be up 40% to get you there. That’s a lot. Maybe more leverage would have improved this score significantly.”

Pricing

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

At 6.71, the price score is lower than the 8.76 average for the same product type.

“It’s a two-point difference, and that’s quite a lot. And yet you’re getting a good buffer and high cap. The amount of leverage on the upside may not be enough, causing this score to be lower than you would expect. The fees are probably a little high too, especially on a relatively short-term product as there isn’t much time to spread the cost.”

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an overall score of 6.38 versus an average of 8.11 for leveraged return notes and 7.73 for all product types.

“The notes look good on the upside, but when you consider the volatility and the risk, you have to give it some thought. If you’re really bullish though, this is a good way to get an attractive return,” he said.

Morgan Stanley & Co. LLC is the agent.

The notes will settle on Wednesday.

The Cusip number is 61766BBY6.

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