Morgan Stanley’s $2.5 million digital basket notes designed for asset allocation, value bet

By Emma Trincal

New York., Feb. 23 – Morgan Stanley Finance LLC’s $2.5 million of 0% buffered digital basket-linked notes due Feb. 11, 2026 linked to a weighted basket of international indexes could be used for a developed market equity asset allocation, advisers said. The digital payout appeared appropriate to boost the lackluster performance of some of the basket components.

The basket consists of the Euro Stoxx 50 index with a 36% weight, the Tokyo Stock Price index with a 26% weight, the FTSE 100 index with a 17% weight, the Swiss Market index with a 12% weight and the S&P/ASX 200 index with a 9% weight, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket finishes at or above initial level, the payout at maturity will be the greater of par plus the basket gain and par plus 19.57%.

Investors will receive par if the basket declines by no more than 10% and will lose 1.1111% for every 1% that the basket declines beyond 10%.

First question

“This is an interesting note. It has a decent upside. But it’s not offering a lot of protection. If something goes bad, you’re geared to the downside,” said Scott Cramer, president of Cramer & Rauchegger.

Prior to examining the terms of the notes, investors should consider the underlying components.

“This is a note for developed markets exposure. Do you have confidence in these indices? That should be the very first question,” he said.

While the structure offered a minimum return with uncapped gains, a serious due diligence should start with asset allocation.

“Don’t go for the shiny object. You need to have a good understanding of what your exposure is going to be,” he said.

Muted growth

“All of these indices include countries that are struggling. Europe is struggling. Japan is struggling too. Will they be in a better shape in two years? Right now, it appears that everybody is doing everything they can to support those economies,” he said.

The European Central Bank, which began to raise interest rates in July 2022 to fight inflation, left them unchanged at its last meeting in January.

Japan’s monetary policy has been accommodative so far.

Cramer said that if the underlying markets had a lukewarm performance, the payout structure on the upside could benefit noteholders.

“If you do it yourself and if the basket is up 1% after two years, you’re not getting 19%,” he said.

“It seems like it’s a good way to get a decent return even if we have anemic growth.

“The risk-reward may be there.”

Unexpected events

But there were tradeoffs.

“You have to give up liquidity and that may be an issue,” he said.

“We could have outside events...macroeconomic or geopolitical events... and you could get stuck.”

The note would be for someone who understands the risk involved with non-U.S. markets.

“It’s an interesting growth note for an allocation to developed markets. But you have to do your homework and carefully review the risks for each of those regions or countries,” he said.

Value bet

Jeff Pietsch, founder of Capital Advisors 360, said the basket could be a tool for asset allocators.

“It looks interesting as a portion of a class allocation,” he said.

There was a benefit in getting uncapped digital gains when investing in markets characterized by a relatively subdued growth.

“Those underlying countries are already priced for a recession, including the U.K., Germany and Japan,” he said.

“You may consider those basket components as a value play. Broadly speaking many of them are trading below their 2021 highs. They’ve been slow-movers in the last decade. Some haven’t done anything for a very long time.”

Given the valuations of the underlying markets, Pietsch said the upside payout was compelling.

“If you expect a positive or flat return, having the booster with no cap can help you outperform a low-beta index,” he said.

Cost, gearing

But Pietsch pointed to some shortcomings.

“The buffer is 10% and it’s a geared buffer. It wouldn’t take that long for the gearing to go against you,” he said.

The 2% fee was another drawback.

“It’s quite high for a two-year, especially for a structure that’s not overly complex,” he said.

To conclude, Pietsch said the notes may be used as a portion of an asset allocation. The upside payout was the appealing part of the structure.

“I don’t expect a lot of price moves in this area, so the uncapped digital payout is attractive.

“But it comes at a cost. The fee is high, and the geared buffer is a concern if those indices go down,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Feb. 20.

The Cusip number is 61771WD62.

The fee is 2%.

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