Morgan Stanley’s jump securities on three indexes show too small of a buffer, advisers say

By Emma Trincal

New York, Feb. 10 – Morgan Stanley Finance LLC’s 0% enhanced buffered jump securities due April 1, 2021 linked to the worst-performing of the S&P 500 index, the Russell 2000 index and the Dow Jones industrial average provide a digital return above a buffer level, which is often attractive if the market is slightly negative. But advisers said the buffer size was not sufficient to make the deal appealing one way or the other.

If the final level of each index is greater than 95% of its initial index level, the payout at maturity will be par plus an upside payment of 10% to 12%, according to an FWP filing with the Securities and Exchange Commission.

The final upside payment will be set at pricing.

Investors will lose 1% for every 1% that the lesser performing index declines beyond 5%.

“I would skip this note,” said Carl Kunhardt, wealth advisor at Quest Capital Management.

“5% is not enough of a buffer. You still have 95% of your money at risk. It’s a downside protection, but it’s not enough to make me get past my reluctance of worst-of.”

Kunhardt avoids investing in worst-of deals whether tied to stocks or indexes.

“I don’t like them with two indices. With three, the risk of losses is compounded.

“What you’re doing is reducing the chances of actually succeeding,” he said.

Small-cap indicator

If he had to call the worst-performer among the three underlying indexes, his first bet would be the Russell 2000; the second would be the Dow.

“Given where we are in the 10th year of the bull market, the Russell is likely to be the one causing the market to plunge. Small-caps almost always lead us in and out of a specific trend,” he said.

“Most people believe we won’t have a correction in 2020. That seems to be the consensus. But the notes mature in April 2021 and analysts have mixed feeling about the chances of a pullback next year.

“If the Russell is down 20%, you lose 15%... Not much of a difference really...”

Kunhardt said he always compares the possible return of a note with that of a long-only position.

“How does this note compare with being long the Russell?

“Do I want to roll the dice not knowing what my exposure will be just for the sake of getting a 12% return?

“I only have a 5% buffer. I’m almost exposed one-to-one on the downside. I just can’t see the advantage.”

Diversification concerns

If the Russell ended up not being the worst-performing index, Kunhardt assumed the Dow Jones industrial average would probably be the second-most promising candidate.

“The S&P 500 is broader. But the Dow is 30 stocks. Concentration equals volatility. It may not be more volatile as the Russell but with 30 stocks, you don’t really know,” he said.

“The problem is that you can’t really model the note in your portfolio without knowing what you’ll end up getting exposed to.

“There’s not a lot of correlation between the Dow and the Russell. That’s another risk factor.

“I see a bunch of opportunities to get tripped out with an almost insignificant buffer.”

Worst-of risk

A 5% buffer would be more satisfactory with a single-asset note, he added.

“I could live with it if it was on one index. A 5% buffer on a note linked to the Russell only may be attractive compared to a long position in the index; but it’s not the case with the worst-of because all of a sudden you have a lot more risk in the product.”

Real-size buffer

Jerry Verseput, president of Veripax Financial Management, agreed.

“You increase the chances of being well below the 95% level with three indices,” he said.

He put the buffer size in perspective by factoring in the unpaid dividends. He assumed the worst-of index would yield 1.5%.

“You’re giving up the dividends. You only have a 3.5% buffer net of dividend. That’s 3.5% less exposure to losses compared to an equity position but you’re exposed to three different indices,” he said.

Tenor and protection

Another problem was to have a small-size buffer over a short tenor.

“This is one of these...It’s too short-term,” he said.

“I’m not sure what it’s doing for you.

“If you’re going to have exposure to stocks you should have a longer timeframe.

“If you do one-year, you should have more downside protection.

“Three-and-a-half percent is almost nothing.

“It’s kind of a solution looking for a problem.”

Longer, better

In his practice, Verseput prefers to extend maturities for his clients so he can get better terms.

“If it’s for long-term investing why not have a long-term note?” he said.

Sometimes shorter-dated securities can be used by short-term investors or traders. But it’s certainly not the case with a structured note, especially one without any autocallable feature, he said.

“You can’t trade it. It’s so short the cost of issuance would hurt you.

“If you think you’ll need your money a year from now, it’s risky. You don’t have enough downside protection.

“If you don’t need the money right away you can generate better terms by going longer.”

“I don’t really see how it can benefit you.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes (Cusip: 61770FKU9) will price on Feb. 28.

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