Morgan Stanley’s securities linked to S&P 500 may beat index while providing some protection

By Emma Trincal

New York, Oct. 1 – Morgan Stanley’s 0% contingent return optimization securities due Oct. 31, 2018 linked to the S&P 500 index give investors a wide range of opportunities to beat the market, said a financial adviser.

For investors looking for safer alternative to a long-only investment, the notes provide a reasonable level of protection.

If the index finishes at or above the 80% trigger level, the payout at maturity will be par of $10 plus the greater of the 10% contingent return and the index return, up to a maximum gain of 50% to 60%. The exact cap will be set a pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index finishes below the 80% trigger level, investors will be fully exposed to losses from the initial index level.

Contingent protection

“The only advantage is that you’re able to be made whole if the index is below par not to exceed 20%,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“I don’t anticipate the index to drop that much over three years, although there are pretty pronounced headwinds that we have to monitor.

“It can be advantageous to somebody who wants to be long the index and who would be happy just to get the coupon. Of course, you would have to be willing to take the risk on the downside in case the index declines by more than 20%.”

10% yield

Although the cap is generous – a 50% to 60% return over three years is about 17% to 20% a year, he said – the main advantage of the structure, the 10% minimum return, is not all that appealing, he said.

“It’s interesting but not super exciting,” he said.

“The 10% coupon over the three-year period is higher than the yield on the index but not a whole lot higher.”

The S&P 500 dividend yield is 2.05%.

“The cap is reasonable. We’re not anticipating the S&P to have a 2013 type of run. I’m not too worried about the cap.”

Conviction

“In this structure, what investors are looking for is probably to get a high probability of return of principal while keeping the yield of the index,” he said.

“It’s not great, but it’s a way to play the asset class in light of some of the headwinds we see in the marketplace.”

He pointed to the uncertainty around interest rates, the strong dollar and signs of a global economic slowdown.

“It’s not a strong-conviction type of investment. It’s fine for someone who values return of principal. Of course you could have the index down by more than 20% three years from now, and then there is no protection, but we haven’t built that scenario in our projections. We think that 20% is a pretty sound level of protection,” he said.

Within the range

Steve Doucette, financial adviser at Proctor Financial, said the main appeal of the notes is to give investors a chance to outperform the market.

“On a three-year, it’s a nice risk-reward,” he said.

“If the index ends up between negative 20% and say plus 9%, you’re going to outperform the market.

“If not, you’re long the index on either side up to a cap on the upside, but I don’t really pay much attention to the cap because nobody is going to complain about 15% per year.”

‘Nice little corridor’

As the market appears to be at a turning point, the notes may enable investors to better adjust to a different environment.

“We’re seeing a little bit of bull market adjustment now,” Doucette said.

“The question is, are we getting into a bear market?”

“It would be bad timing if at maturity the S&P was down by more than 20%.

“But the odds are pretty good that you’ll be within that range between negative 20% and plus 10%.

“It’s a nice little corridor for the uncertainties in the market.

“We don’t know when a bear market is going to hit ... if it’s going to be tomorrow or in two years. But since we’re already down 10% from the last peak in May, the notes already provide a nice little buffer.”

On the upside, a “risk” would be to miss on some of the index gains. Doucette said such scenario is unlikely.

“If you’re bullish, of course this is not a good note. But you still can be quite bullish. Anyone who expects to make more than 15% to 20% a year in the next three years has unrealistic expectations.

“The downside barrier with the 10% minimum gives you more than just par. It’s better than a typical barrier.

“In a way it’s a modified absolute return note. You can outperform by 30%.

“You lose only if the S&P falls more than 20% three years from now.

“I think it can provide investors a lot of comfort.”

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

The notes will price on Oct. 27 and settle on Oct. 30.

The Cusip number is 61765R594.

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