Morgan Stanley’s $18.79 million autocalls on semiconductor ETF prone to volatility, Fed risk

By Emma Trincal

New York, Dec. 20 – Morgan Stanley Finance LLC’s $18.79 million of 0% autocallable trigger participation securities due Dec. 14, 2023 linked to the iShares Semiconductor ETF present risks of increased volatility as the economy turns into a new era with higher interest rate hikes looming and inflation persisting, a financial adviser said.

The notes will be automatically called at par plus a 15.15% call premium if the fund closes at or above its initial level on Jan. 3, 2023, according to a 424B2 filing with the Securities and Exchange Commission.

If the final fund level is greater than the initial fund level, the payout at maturity will be par plus the fund return.

If the final fund level is less than or equal to the initial fund level but is greater than or equal to the trigger level, 80% of the initial fund level, the payout will be par. Otherwise, investors will lose 1% for every 1% that the fund declines from its initial level.

The iShares semiconductor ETF is the new name for the iShares PHLX semiconductor ETF. The fund was re-baptized in June when the underlying index’s name changed from the PHLX semiconductor sector index to the ICE semiconductor index, according to the iShares fund prospectus.

Conviction needed

Jerry Verseput, president of Veripax Wealth Management, said the terms of the notes were acceptable. But he did not have any appetite for the semiconductor industry at this time.

“It’s hard to give an opinion on this deal. I guess if you want to get exposure to semiconductors, it’s a great way to do it,” he said.

“If you can get 15% in one year, that’s fantastic and having a 20% barrier is good, too.

“You just have to be committed to the sector. I don’t know if I am.”

But Verseput added that the timeframe was not optimal for an asset class prone to volatility.

Turning point

“It’s a two-year. A lot can happen in two years,” he said.

“Tech has been the leading sector for the past two years.

“But the economy is going to go on a diet. The Fed is going to scale back its bond purchases.

“If less capital is flowing into the system, it’s going to hurt growth stocks more than value stocks.”

The recent surge of the Omicron variant gave a boost to tech stocks. The fund hit a 52-week high on Dec. 7 amid mounting Omicron worries and headlines about the new variant.

From its 52-week low exactly one year ago to it its high of two weeks ago, the semiconductor fund has surged 50%, more than twice the return of the S&P 500 index during the same period.

Verseput does not believe this growth is sustainable.

“We may see different Covid variants... But I don’t know if Corona is going to push tech the way it pushed it for two years,” he said.

From virus to inflation

While the pandemic may have driven some of the growth for the “stay-at-home” stocks, the trend is running out of speed, he said.

“There’s been a huge migration. People have set up their home offices. That’s largely done by now,” he said.

More importantly, the performance of technology stocks could be hampered in a rising interest rate environment, he said.

“We’re getting into a different era,” he said.

“Inflation tends to hurt growth stocks. Future cash flows are discounted at higher rates. It doesn’t look as good for projected growth.”

Technology and growth stocks in general have longer-term earnings. Therefore, earnings are worth less today when discounted at a higher interest rate, he explained.

“So far rates were low. You had a lot of liquidity in the system. It’s been very positive for growth stocks whose future cash flows were discounted at a lower rate.”

“Now we’re going to see a reversal. If the curve steepens and rates go up, it’s going to benefit financials and value stocks in general. Tech stocks on the other hand are going to be vulnerable.”

Since the Federal Reserve’s meeting last week, the market expects three rate hikes in 2022 and an accelerated pace of tapering.

“I wouldn’t get into semiconductors right now. But again, if your plan is to invest in this industry it’s a good deal.”

Speculative

Jerrod Dawson, director of investment research at Quest Capital Management did not like the terms of the notes.

“I don’t really see a lot of benefits here,” he said.

He stressed the high volatility of the semiconductor industry, adding that the 20% downside protection was inadequate.

“You have a lot of momentum investors behind the volatility in this area. The Nvdias of the world... their biggest customers are the Bitcoin people.

“It’s a highly speculative bet.”

Nvidia Corp. is the third largest holding in the fund with a 6.94% weight.

The company designs graphics processing units (GPUs) that are used in gaming, automotive and also crypto mining.

The stock price more than doubled this year.

Terms

“I don’t think 20% is commensurate with the risk,” he said.

“The 15% call premium is actually a small window to outperform. If the index is up 16% you lose. If it’s up 14% or 15%, you’re no better off. It would have to be flattish to give you any benefit.

“On the upside, you’re only getting one-to-one.

“I’d rather be long the ETF with a volatile index like this.

“You’d have to give me a bigger upside kicker or a bigger buffer to convince me to give up liquidity.”

Notional sales involving the use of the former PHLX index amounted to $135 million this year in four deals, according to data compiled by Prospect News.

Another popular underlier for the semiconductor industry was the VanEck Vectors Semiconductor, which accounted for $75 million issued in 10 deals.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Dec. 15.

The Cusip number is 61773G762.

The fee is 2.3%.

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