Morgan Stanley’s $20 million autocalls on Invesco QQQ trust show one-year tenor, buffer

By Emma Trincal

New York, June 10 – Morgan Stanley Finance LLC’s $20 million of contingent income buffered autocallable securities due June 13, 2022, linked to the Invesco QQQ trust, series 1 introduced relatively unusual features for an autocallable note such as a buffer and a short tenor. Overall, advisers expressed concerns about the underlying volatility, preferring longer tenors and more downside protection.

Each month, the notes will pay a contingent coupon at the rate of 9.51% per year if the underlier closes at or above its coupon barrier level, 90% of its initial level, on the determination date for that month. The notes will also pay any previously unpaid contingent coupons from prior observation dates, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the coupon and any previously unpaid coupons if the underlier closes at or above its initial level on any monthly determination date.

The payout at maturity will be par plus any coupon payments unless the underlier finishes below its buffer level, 90% of its initial level, in which case investors will lose 1.1111% for every 1% that the underlier declines beyond 10%.

Volatile underlying

“It’s always amazing to me...getting into such a potentially volatile asset class with a 10% buffer. Sure, it’s nice to have a buffer but this is not much,” said Steve Doucette, financial adviser at Proctor Financial.

As always with autocalls, the likelihood of an early redemption, if any, is greater on the first call dates.

“You can get 1% or 2%, get called and for that, you had to take a huge amount of risk,” he said.

“It’s basically a capped return of 9.5% for un unlimited downside.

The 1.11 multiple could in theory cause investors to lose their entire principal although such scenario would be extreme as the index would have to drop close to zero, he noted.

Steady return

Buyers of the notes would be looking for moderate moves in the Invesco QQQ trust.

“You have to believe that the index won’t go down much, that it will trade range bound,” he said.

“You’re trying to collect a coupon from an index trading from -10% to +10%. That’s where you outperform, but that’s a really tiny range.

The risk-adjusted return was an issue, for this adviser.

“You put 90% of your money at risk for a 9% maximum return. That doesn’t sound too exciting to me. And you’re taking a huge risk on the Nasdaq.”

Longer is better

Doucette said he does buy autocallables. But the note would not match his criteria.

“We go out two or three years. This is just a one-year duration. You’re not going to be able to collect that much coupon,” he said.

He would also change the underlying.

“I would use one plain-vanilla index or a combination of indexes that are less volatile than the Nasdaq. I’d look for an 8% to 9% contingent coupon with a 40% barrier.

“If you’re looking for coupon exposure, you’re better off with something less volatile than QQQ.”

Not into stocks

In general, Doucette said he stays away from autocallable products that are overly risky such as those linked to high volatility assets designed to extract as much premium as possible especially if the protection is inadequate.

“The risk return is usually poor when you play with highly volatile assets,” he said.

“It’s like those single-stock autocalls which dominate this market. It’s unbelievable how many of these deals get done. They’re sold, not bought. I don’t understand them. Why take such high exposure to volatility just to collect a coupon that caps your upside?”

Doucette said it’s impossible to predict what the Nasdaq performance will be a year from now.

“It’s been outperforming for a while and then we saw this rotation into other parts of the economy, people betting on a strong reopening. The Nasdaq was down a little bit last month because of inflation. But it has rebounded. It’s very choppy. A year from now, it may go down or it may go up. Who knows?”

Flexible features

Matt Medeiros, president, and chief executive of the Institute for Wealth Management was also concerned about the volatility in the underlying exposure.

“There’s so much uncertainty in the market looking forward. The note is interesting in a way. You can tell it’s trying to address that uncertainty by introducing some flexibility, for instance the short-term maturity and the monthly payments,” he said.

But the “downside” of this was the potential big moves in the ETF price both on the upside and on the downside.

“Because of where we are in the market cycle, this underlying could substantially exceed the coupon while it could also easily drop more than 10%,” he said.

Buffer, memory

Some aspects of the structure were positive, such as the existence of a buffer instead of the more commonly used barrier as well as the cumulative nature of the coupon payments.

“It’s good to have a buffer. But I’m not a big fan of geared buffers,” he said.

“Being able to catch up with past unpaid coupon is also a positive. But it adds another moving part.

“I don’t necessarily like taking something that I expect to be volatile and adding more complexity.

“I just wonder if there’s not a way to accomplish something similar but with more predictability.”

Apply caution

If he had to redesign the notes, Medeiros would extend the maturity and add more protection. The longer term may allow for a higher coupon, he said.

“Autocalls are everywhere, and we’ll see more of that simply because they give you more attractive yields than most fixed-income instruments.

“The key is to carefully select your underlying, your timeframe and make sure you are on the right side of the market cycle.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent with J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA as placement agents.

The notes settled Thursday.

The Cusip number is 61771VY20.

The fee is 0.25%

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