Morgan Stanley’s buffered PLUS tied to Euro Stoxx 50 offer relative value in volatile market

By Emma Trincal

New York, July 14 – Morgan Stanley Finance LLC’s 0% buffered Performance Leveraged Upside Securities due Feb. 5, 2019 linked to the Euro Stoxx 50 index, offer a tactical play designed to take advantage of a recent selloff in the eurozone market as a result of the U.K. vote to leave the European Union, also known as Brexit, buysiders said.

The notes are also a long-term value play as European equities have for some time been trading at lower valuations than U.S. stocks, they noted.

While the value strategy makes sense, the buysiders commented, it is not without risk. As volatility remains high in this part of the world, they said they would like to see more downside protection in the structure.

The payout at maturity will be par plus double any index gain, up to a maximum return of 31%, according to an FWP filing with the Securities and Exchange Commission.

The cap represents for investors an annualized compounded return of 11.40%.

Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

The notes are guaranteed by Morgan Stanley.

Mildly bullish

“The terms of the notes are straightforward,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“As equity expectations are rather low at the moment, having a modest return on the asset class multiplied by leverage is a nice enhancement to the strategy.”

The deal will price three weeks after the shock created by Brexit. During that time, fewer deals with European equity exposure have been brought to market. The level of the Euro Stoxx 50 index immediately tumbled then quickly rebounded along with U.S. stocks.

Relative value

“As we get to see the Brexit in the rearview mirror, the Euro Stoxx appears to be a good value,” said Medeiros.

Even before Brexit, U.S. investors noticed the compelling value offered by the Eurozone on a relative basis compared to domestic stocks, he noted.

“The U.S. market is becoming overvalued whereas it’s reasonable to conceive that European share prices will be appreciating over the next few years.”

Term, buffer

The two-and-a-half year tenor was a “decent” timeframe, he added.

“It’s neither short term nor long term. It’s mid-term.

“I think the cap and the buffer are adequately proportionate to the amount of time you get to hold the notes.

“It’s a fair trade.”

One aspect of the deal however could have been enhanced, he said.

“A 10% buffer is nice. But Europe is a market where you still have a substantial amount of volatility. I would like to see a larger buffer on this note even though I think it’s fairly priced given the structure and the strategy.”

Rebalancing

Steve Doucette, financial adviser at Proctor Financial, said there was nothing wrong with the terms of the notes but agreed the structure could be much improved with more protection on the downside.

“It’s a nice plain-vanilla note,” he said.

“You’re not going to complain about 11.50% a year. What I would probably look for is a little bit more on the downside.”

Doucette said he liked Europe as an asset class from a valuation perspective.

“Europe has been lagging the U.S. for a while now. On the chart, the Euro Stoxx and the S&P are going into opposite directions.

“If you’re a little bit of a contrarian, now is a good time to switch out of the U.S. and go into the underperforming asset classes.

“We tell our clients to keep a global exposure. It’s time to rebalance into those unloved asset classes, Europe for instance and emerging markets.

“Time to buy your losers and sell your winners.”

Bear coming

While this asset allocation strategy makes sense over the long run, investors across most asset classes are facing the risk of a major correction or bear market, which would derail the best plans to diversify a portfolio, he noted.

For Doucette, the coming of a bear market is inevitable.

“Here we are, eight years going into a bull market. We know we’re going to have a bear market pullback. The question is when,” he said.

More buffer

“I like the notes because you can outperform a little bit on either side.

“The cap is good as it is. My concern would be the downside if we hit a bear market.

“I would probably give up a little bit more increase, perhaps take less leverage, to get a bigger buffer.

“You don’t want to completely eliminate the leverage. A one-to-one exposure would kill your chances to outperform on the upside.

“But I can imagine reducing the leverage or maybe giving up some of the cap to get a 15% buffer.

“It’s a pretty good deal. But you want to be cautious in this environment.”

Morgan Stanley & Co. LLC is the agent.

The notes will price on Friday.

The Cusip number is 61766B648.

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