Morgan Stanley’s $106.24 million notes tied to palladium ranks third among commodities deals

By Emma Trincal

New York, Nov. 25 – Morgan Stanley priced $106.24 million of 0% buffered return enhanced notes due Dec. 9, 2015 linked to palladium, one of the top commodities deals to hit the market this year.

The notes offered 1.163 times leverage on the upside up to an 11.63% cap, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the price declines by 10% or less and will lose 1.1111% for every 1% that it declines beyond 10%.

A big one

The deal is the third commodity-based offering for this year after JPMorgan Chase & Co.’s $155.7 million add-on of 0% return notes due Nov. 27, 2018 linked to the J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return index in July and Deutsche Bank AG, London Branch’s $126.59 million of 0% knock-out notes due July 21, 2015 linked to the West Texas Intermediate crude oil, also sold by JPMorgan in May.

“This absolutely seems like an institutional trade,” said Dean Zayed, chief executive of Brookstone Capital Management.

“It could be some sort of hedge on another position that this buyer holds or an inflation-type hedge to complement an existing portfolio. It is definitely the size and the specificity of the underlying that leads me to think that...it just smells of institutional!”

Jonathan Tiemann, president of Tiemann Investment Advisors, LLC agreed.

“I would be surprised if this was sold to retail. It’s not the type of underlying asset people are familiar with,” he said.

A bullish trend

While many commodities-linked notes used to be based on a broad index, recent large deals have been structured around a single commodity, according to data compiled by Prospect News.

“A commodity is easier to track when you can buy it through simple ETFs, something you couldn’t do just a few years ago. The ease of ETFs allows obscure asset classes or investment opportunities to get greater exposure and more investor attention,” said Zayed.

He added that the choice of palladium in a larger deal did not come as a total surprise.

“Commodities are the classic, text book inflation hedge, and palladium has recently emerged as a widely monitored element within the commodities universe,” he said.

“It’s a commodity positioned as one that will do well in inflationary times.

Palladium has recorded a good performance this year compared to the broader commodity market.

The S&P GSCI Palladium Total Return index has gained 9.52% this year versus a nearly 17% decline for the S&P GSCI Total Return commodity index. Palladium slightly underperformed the S&P 500 index, which is up 12% this year, but the metal remains a top-performing sub-sector in the commodity space.

“Palladium is used in the auto industry and when car sales increase, demand for the metal goes up too,” said Tiemann.

Short volatility

“What the note is doing compared to owning the metal directly is buying palladium while shorting its volatility. You get accelerated loss on the downside beyond the buffer and you sacrifice the upside by capping the return to 11.63%,” he added.

“It’s probably straightforward for Morgan Stanley to hedge it. They may already have a big position on it.

“The cap is the same 10% plus the upside leverage. If the price of palladium goes up by 10%, you hit the cap. If it drops by 10% the leverage on the downside kicks in. Somehow it’s sort of symmetrical. It may have worked out this way when they priced it out. The esthetics of it might look better.

“You only want to buy the notes if you are interested in palladium and want exposure. You also have to believe that volatility for this commodity is overpriced. You’re selling your upside for the leverage and you accept the geared buffer for the sake of protection,” he said.

Not too bullish

The notes had to fit a certain risk-reward profile, he said.

“It seems to reflect a mildly bullish position with respect to the price of palladium. Anybody super bullish on it would not accept this type of cap,” he said.

“Absent inflation, I think the appreciation potential is good, but somewhat limited, between 5% and 7% above the rate of inflation.

“The terms are decent at best; you get some protection but not a whole lot with just a 10% buffer. With the cap, the note has really created a narrow band of returns but any sharp move on the downside can lead to outsized losses given the 1.1x on the downside,” he said.

The notes priced on Thursday.

Morgan Stanley & Co. LLC.

The Cusip No. is 61762GCM4.

The fee is 1%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.