Morgan Stanley's jump securities on iShares MSCI EM, Euro Stoxx 50: high upside, no buffer

By Emma Trincal

New York, June 17 - Morgan Stanley's jump securities on the iShares MSCI Emerging Markets index fund and the Euro Stoxx 50 index may appeal to investors looking for high potential return in a short-term period but willing to take a significant amount of risk, said structured products analyst Suzi Hampson of Future Value Consultants.

Hampson looked at Morgan Stanley's 0% jump securities due Dec. 17, 2010 linked to the iShares MSCI Emerging Markets index fund with a 60% weight and the Euro Stoxx 50 index with a 40% weight.

If the final basket level is greater than the initial level, the payout at maturity will be par of $10 plus an upside payment of 10%.

Investors will be fully exposed to the basket decline.

High potential

"If at maturity in just six months your underlying basket ends up higher, even by 1%, you get a 10% payout, which is a 20% annual return. That's very high," said Hampson.

"For an investor happy to take on risk, this is pretty attractive," she said.

Hampson put in perspective the "upside" risk posed by a 10% cap, which is stated in the prospectus.

No protection

"Obviously, the risk is on the downside because you do not have any buffer or any form of downside protection with these notes," she said.

She said that the structure resembled some growth products in that the payout, if any, gets paid at maturity. As such, the notes may appeal to growth investors, she said.

Yet the fixed payment that applies if the basket was to finish higher at maturity would make it also attractive to income investors, especially given its 10% level, she said.

She also distinguished the product from a reverse convertible, which pays a coupon no matter what the underlying does.

One characteristic those notes do not share with most products, she added, including reverse convertibles and growth products alike, is the absence of a buffer put in place to limit losses, she said.

"If the basket falls by 20%, you lose 20%. That's a lot to lose in six months," she said.

"You're capped on the upside but you can lose your entire principal on the downside," she noted.

Volatile underlying

Hampson said that the risk was compounded by the implied volatilities of the two components of the underlying basket.

The iShares MSCI Emerging Markets index fund, which has the heaviest weight of 60%, is also the more volatile of the two. Its implied volatility is 38.

The Euro Stoxx 50 index has a lower volatility of 26, she said.

"Again any decline in the basket will cause investors to incur losses. And since this outcome depends on the underlying volatility of the basket and that with emerging markets, we have a pretty volatile fund, this is a product that's as risky as you can get," Hampson said.

High correlation

An often overlooked risk factor is the lack of correlation between the two components of an underlying basket, Hampson said.

"Changes in the value of one of the basket components may offset the value of the other. Movements in the values of the basket components may not correlate with each other," is how the prospectus described the risk.

With these notes, the correlation between the iShares MSCI index fund and the Euro Stoxx 50 is "quite high," said Hampson, saying it was 77%.

"The higher the correlation, the better it is for the investor," she said. "Because if the correlation between the two constituents of a basket is low or negative, as one moves up, the other moves down and they're cancelling each other out. You expect them to be correlated, and that's what you have here."

7.30 riskmap

But the correlation does not offset the risk posed by the absence of a buffer in a note tied to a volatile underlying basket, she said. As a result, the riskmap for those notes - a Future Value Consultants' rating that measures the risk associated with a product - is 7.30.

Despite high potential gains, the risk is so high, Hampson noted, that it has a detrimental impact on the return rating, which is Future Value Consultant's indicator of the risk-adjusted return of the notes.

Calculated from Monte Carlo simulations, the return rating of the notes is 3.39 on a scale of zero to 10.

Gains and losses

Hampson looked at the probability tables of the product return outcomes, which is also extracted from the Monte Carlo simulation. It takes into account various parameters such as volatility, dividends and interest rates.

The odds of earning a positive return are 52.4% for this product while investors have a 47.6% probability of incurring losses, according to the report.

While the prognostic of making a gain is high, the risk of losses is high enough to lower the return score, Hampson explained.

"This rating compares to other structured products where the probability of losing money is less than that because usually most structured products have some sort of downside protection or buffer built in," she said.

"These notes could appeal to both an income-seeker and a growth investor as long as they're happy with the risk, because the risk element is the most important here," she said.

A small overall

The Value rating of the product, which is Future Value Consultants' measure on a scale of zero to 10 of how much money the issuer spent directly on the assets versus other transaction costs such as direct fees and profit margin on the underlying derivative, is 4.66.

"It's little bit below average. It means that the issuer did not spend that much on the assets," said Hampson.

The simplicity rating which measures how easy it is to understand a structure is eight for the deal on a scale of zero to 10.

Averaging the three scores weighted 40% to the value score, 40% to the return score and 20% to the simplicity score, Future Value Consultants comes up with its overall rating, which measures on the same scale the overall quality of a deal. Those notes only show a 4.82 overall rating.

Morgan Stanley priced $5.06 million of the jump securities on June 14.

© 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.