Morgan Stanley’s trigger performance notes linked to Euro Stoxx 50 target long-term investors

By Emma Trincal

New York, June 24 – Morgan Stanley’s 0% trigger performance securities due June 28, 2024 linked to the Euro Stoxx 50 index offer good terms, but investors are likely to be uneasy about the 10-year duration, according to a buysider.

The 10-year tenor represents indeed “a problem” except for long-term players who may find that the benefits of the payout structure more than offset the lack of liquidity, another buysider noted.

If the index return is positive, the payout at maturity will be par of $10 plus 210% to 215% of the index return, with the exact participation rate to be determined at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 50% and will be fully exposed to losses from the initial level if it falls by more than 50%.

Behind the Fed

“A 10-year and nothing in between? That’s a bit problematic,” said Dean Zayed, chief executive of Brookstone Capital Management.

Zayed said he likes the underlying index, the blue-chip benchmark for the euro zone equity market.

“My take on Europe for the next several years is that their monetary policy is several years behind the U.S. They have committed to doing their own version of QE,” he said.

“I am very bullish on European stocks because there is much more to come in terms of accommodative monetary policy. They European Central Bank still lags the Fed.”

Great terms

Zayed said that he also likes the structure of the notes.

“The leverage in this deal, the no-cap, the barrier are nothing short of fabulous,” he said.

But the combination of a good underlying index and a strong structure is not necessarily a buy.

“It’s just that not earning anything in between, no dividend, no coupon, makes it a very tough proposition for clients, especially when you’re talking of holding a note for 10 years,” he said.

“Some argue that you can always redeem early on the secondary market. I disagree. It distorts the purpose of structured notes.”

The prospectus states in the risk section that investors have to be willing to hold the notes for 10 years and accept that there “may be little or no secondary market” for the securities.

“You just don’t know what the price is going to be,” Zayed said.

“It may not be correlated to the growth of the underlying. You can’t go with a note like this one thinking that you can sell early. You should have the goal in mind to hold it until it matures.”

Deal-breaker

The only unacceptable term in the deal is its duration, he added.

“The risk-reward is highly attractive excluding this 10-year term,” he said.

“Most of these large indices over 10 years are likely to deliver strong returns.

“Europe is behind us in terms of its economic stimulus. As a result, Europe may offer even better upside than U.S. markets.

“But the 10-year tenor is a deal-breaker despite the phenomenal terms. You’re not going to get investors willing to earn no coupon and no dividend during such a long period of time. It’s an absolute deal-breaker.”

For Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, some investors may be willing to give up liquidity for 10 years, but they may have to have good reasons to do so and should be long-term investors by nature.

Investors who may consider the product would have to be sufficiently bullish to forego the dividend payments of the index. The Euro Stoxx 50 index has a 2.65% dividend yield.

No dividends

“The problem is the 10-year [tenor],” Tiemann said.

“As always for a structured investment, you have to sacrifice the dividends and you have to take the credit risk. In this case, you have a 10-year exposure to Morgan Stanley,” he said.

Tiemann said that giving up dividends for a long period of time has return consequences that investors would have to analyze before considering buying the notes.

“Unlike someone who buys the ETF, you are not going to collect 2.6% a year. You’re not taking advantage of the reinvestment of dividends for a period of 10 years. The note is only tied to the price appreciation of the index, not its total return,” he said.

The break-even for investors is when the price appreciation of the index becomes greater than the dividend, he explained.

While the price component of the total return would have to be lower than 2.6% in order for investors to underperform the index – which Tiemann conceded is a small increase – investors would still have to take into account the non-payment of dividends in their return expectations, especially with a yield already high and possibly growing higher with time, he said.

So long

The long duration is the second problematic aspect of the deal, according to Tiemann, although some investors may not find it to be an obstacle.

“It’s kind of an odd structure because it’s so long,” he said.

“If the market for instance ends up flat after 10 years, you forfeited the dividends for 10 years and had no liquidity.

“If the price doubles in 10 years, then you get four times your money.

“I suppose somebody may consider it as part of a very long-term investment.

“The pricing is fine if you’re willing to wait that long.”

Long-term vol

Some investors may consider the notes as a long-term volatility play, he added.

“This trade is probably for someone who expects volatility to pick up in time. You might buy if you think volatility is going to increase, but then you need to keep in mind that you get the risk on the downside. However, the 50% barrier gives you some comfort in terms of protection even in the event of a really big increase in volatility,” he said.

“Volatility does not just mean that prices are plummeting. You can have sharp price moves on the upside too. People always forget that.

“If you’re expecting a strong bullish move, the upside is attractive in two ways: it’s unlimited and you have twice the price return of the index.

“On the downside your exposure is only one to one. You have a 50% barrier, which protects you against huge losses. It’s almost a protection against tail risk. That structure would seem to work in a high-volatility scenario because leverage is asymmetrical and because the barrier is very deep.

“Even if you don’t foresee large price swings, if you’re only moderately bullish, the leverage is enticing.

“I guess this is a note that may work for a number of bulls, but they would all have to be long-term investors.”

The notes (Cusip: 61761S596) are expected to price on Thursday and settle on June 30.

Morgan Stanley & Co. LLC is the agent with UBS Financial Services Inc. as dealer.

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