Morgan Stanley's two-year buffered PLUS tied to global equities: good buffer, debatable basket

By Emma Trincal

New York, June 21 - Morgan Stanley's 0% buffered Performance Leveraged Upside Securities due July 2014 linked to an index and four exchange-traded funds offer attractive terms to bullish investors seeking a diversified allocation to global equities, according to sources.

The number of basket components and their respective weights, however, were more a matter of debate, the sources said.

The basket consists of the SPDR S&P 500 ETF Trust with a 40% weight, the iShares Russell 2000 index fund with a 20% weight, the iShares MSCI Emerging Markets index fund with a 15% weight, the S&P 100 index with a 15% weight and the iShares MSCI EAFE index fund with a 10% weight, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10.00 plus double any basket gain, up to a maximum return of 23% to 27%. The exact cap will be set at pricing.

Investors will receive par if the basket falls by up to 20% and will lose 1% for every 1% that it declines beyond 20%.

20% buffer

Steve Doucette, financial adviser at Proctor Financial, noted the attractive buffer size.

"Buffers have dropped down to 15%. You don't see that many 20% buffers," he said.

"There is a couple out there on my screen, but they don't necessarily give you the leverage. One is a three-year on the SPDR [S&P 500], and there's no two-times leverage.

"We see a few, but they tend to have longer durations and less upside."

A hedge fund manager said the product was well designed for bulls.

"I don't particularly like the long equities right now. Over the next month, I think we'll go down quite steeply because of the failure of the Fed to intervene," he said.

"But this note is fine if you're bullish.

"If you want to make an equity investment and want some downside protection, it seems like a good idea."

The underlying basket gives investors a 75% exposure to the U.S. equity market versus 25% outside of the United States, with 10% going into developed countries via the iShares MSCI EAFE ETF and 15% to emerging markets, noted Paul Dietrich, chairman and chief executive of Foxhall Capital Management.

"It sounds attractive. I believe the U.S. will outperform over the next two years. The U.S. will outperform over emerging markets," he said.

"The 12% to 14% maximum return per year is pretty good. You don't get dividends, so maybe you're losing 2%, but still, I think it's a good return."

One size doesn't fit all

If the structure appeared attractive, the underlying basket was not necessarily adapted to all bulls, sources said.

Doucette said that the notes offered an easy tool for investors who do not want to or lack the time to go over their own asset allocation process.

"It's a neat note for folks who want to hedge and leverage in a global basket. It's a nice, convenient way to avoid doing your own allocation," he said.

"You could get more upside on the emerging markets or the EAFE fund, though.

"I'm not suggesting that 12% is not a good cap, but you put an overlay across all those different asset classes. We would probably pick this one apart and do these asset allocations individually. The EAFE fund, for instance, due to Europe is a bit volatile. If you carve them out in a separate note, you could get a better return, especially if Europe resolves its problems and China doesn't fall on its face. As we look at each asset class, that's when we determine what's the proper leverage or barrier that we need."

U.S., Europe exposure

In terms of asset weights, Doucette found that the basket was "over-allocated" to the United States.

"Would we do 55% exposure to large caps? Probably not," he said.

He added up the 40% and 15% weight of the SPDR S&P 500 ETF and the S&P 100 index respectively to determine this 55% large-cap allocation.

Moreover, the small-cap ETF fund (Russell 2000) with its 20% weight made the product even more "over-exposed" to the U.S. equity market than it needed to be, according to Doucette.

On the other hand, Dietrich was concerned with the existence in the basket of the EAFE index ETF, which reflects the performance of 22 developed market countries excluding the United States and Canada.

The EAFE acronym stands for Europe, Australasia and Far East.

"My only criticism is that I can't imagine that over the next two years, the EAFE, which is heavily made of European stocks, is going to be outperforming," Dietrich said.

The "European economic risk" is listed as one of the risks in the iShares prospectus as nearly two-thirds of the index is allocated to the greater European region.

"I don't know of any economist who believes that the European Union is going to get its act together in a way to solve the problems they're facing," he said.

"That said, the EAFE component is only 10%. That's not outrageous.

"But I personally would have stayed away from Europe over the next two years."

Morgan Stanley & Co. LLC is the agent, and Morgan Stanley Smith Barney LLC will handle distribution.

The notes will price and settle in June.

The Cusip number is 61755S362.

The fees are 2.25%.

© 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.