Morgan Stanley’s dual directional on indexes incorporate fixed coupon into digital structure

By Emma Trincal

New York, Dec. 21 – Morgan Stanley Finance LLC’s dual directional trigger jump securities due Dec. 23, 2027 linked to the Nasdaq-100 index, the Russell 2000 index and the Dow Jones industrial average offered a bit of innovation in adding a fixed coupon into a traditional uncapped digital note, sources noted.

A fixed quarterly coupon at an annual rate of 2% will be paid during the first four years, according to an FWP filing with the Securities and Exchange Commission.

If the return of the worst-performing index is positive, the payout at maturity will be the greater of par plus that index’s return and par plus 47.5%.

Investors will receive a 1% gain for each 1% loss in the worst-performing index if that index declines but finishes at or above the 75% downside threshold and will lose 1% for every 1% decline if the worst-performing index ends below its downside threshold.

A new thing

“It’s kind of interesting. I like that coupon. I haven’t seen that structure before. It’s a little bit different,” said Mark Dueholm, chief fixed-income trader at Landolt Securities.

While uncapped digital payouts with a barrier and absolute return on the downside are relatively common, the addition of a fixed coupon to the lot was not, he noted.

“Obviously after four years, the 2% coupon adds a little bit of a buffer,” he said.

75% barrier

Yet the size of the barrier was not sufficient to make the notes appropriate for his clients.

“We cater to very conservative investors. For us, 25% wouldn’t be enough of a cushion,” he said.

Dueholm said his firm offers for the most part income-oriented structured notes rather than growth or bullet notes.

“Usually, we want 40% protection on income notes. We just did a three-year with a 9.5% contingent coupon and a 40% barrier on three indices.”

“We don’t typically do absolute return notes because they don’t pay income. This product is an exception, but the coupon is very modest.

“As a general rule, we shy away from notes that don’t pay income except for snowballs,” he said.

Mildly bullish

The notes offered a good balance between growth and safety, said a financial adviser, who liked the offering.

“The 2% coupon is a new concept. It looks like it’s there to take care of the dividends, so you don’t have the opportunity cost loss,” he said.

On the upside, investors are guaranteed a 55.5% minimum return, he noted.

“If you add to the 47.5% minimum four-years’ worth of coupon payments, that’s about 11% a year as a minimum and you’re not capped,” he said.

The exclusion of the S&P 500 index among the three underlying indexes was probably a deliberate choice intended to boost the premium, he added. That’s because the Dow Jones industrial average and the Nasdaq-100 exhibit a slightly lower correlation to one another than for instance the S&P 500 to the Nasdaq, which are both tech-heavy indexes, he explained.

The note matched a moderately bullish strategy, he added.

“This is for people who don’t expect the market to be up a ton next year. The expectation is that over five years, it’s going to be up less than 47%, perhaps even much less,” he said.

Absolute return

The structure on the downside was relatively defensive for that type of tenor, he noted.

“People are anxious about next year, so the barrier and absolute return are there to lower the risk and possibly, take advantage of a market decline,” he said.

If the market is down 25%, you get a 25% positive return. The only way you lose money is if you breach that barrier. If it’s down 26% it stinks, but you’re in the same boat as an ETF. The barrier at least is cutting some of the downside.”

The amount of contingent protection seemed reasonable to this adviser.

“If you look at historical data, the chances of being down 25% over five years is less than 4%,” he said.

The note could have even been designed with a more aggressive tilt.

“Some advisers may push for a smaller barrier so they can increase the digital. It all depends on the client’s view. But this is not an aggressively bullish note. It’s more of a response to the angst people feel in this market,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes priced on Dec. 20 and will settle on Dec. 23.

The Cusip number is 61774TFG2.

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