Morgan Stanley’s $3.1 million PLUS linked to basket of stocks offer targeted bet on housing

By Emma Trincal

New York, Aug. 25 – Morgan Stanley’s $3.1 million of 0% Performance Leveraged Upside Securities due Aug. 25, 2017 linked to an equally weighted basket of eight common stocks enable investors to express a view on housing across diverse sectors in a theme-specific play, a buysider said.

The underlying stocks are Bed Bath & Beyond Inc., Home Depot, Inc., Trex Co., Inc., Mohawk Industries, Inc., Masonite International Corp., D.R. Horton, Inc., Zillow Group, Inc. and SolarCity Corp., according to a 424B2 filing with the Securities and Exchange Commission.

If the basket return is positive, the payout at maturity will be par plus 300% of the basket return, up to a maximum return of 25%. If the basket return is negative, investors will be fully exposed to the decline.

The stocks are part of different sectors, including consumer discretionary (Bed Bath & Beyond, Home Depot, Mohawk Industries, D.R. Horton), industrials (Trex, Masonite International, SolarCity) and information technology (Zillow Group). But all are related to housing from homebuilding to home improvement and from technology to home furnishing.

Housing

“It’s interesting. It’s the first time I’ve seen a basket like this one. It’s a thematic product with a story. It’s how these products should be sold,” said Jack Ablin, chief investment officer of BMO Private Bank.

Investors in the notes have a moderately bullish view on housing stocks.

“It’s a bullish view on housing. It’s one where you believe interest rates are going to stay low and mortgage rates will remain cheap. It’s a good play,” said Ablin.

“If dividends aren’t too high, that would be an advantage.”

Only a few stocks in the underlying basket pay dividends, such as Home Depot, with a 2.10% dividend yield, and D.H. Horton, which offers a yield of 0.85%. Ablin said low-yielding basket components benefit investors as they are giving up less return. Unlike shareholders, investors in the notes are not entitled to receive dividends.

“That’s probably a play on the Fed too. The Fed definitely wants to see the housing market flourish,” he added.

Downside

The lack of any barrier or buffer on the downside makes the structure “a little bit risky,” he said.

But investors in the notes are bullish by definition, although their return expectations are not very high.

“You’re only anticipating modest gains, otherwise you would want to own the stocks outright,” he said.

“It’s a range-band view, a mildly bullish view on housing. You don’t see a big price increase, but you don’t expect prices to drop either.”

A variety of structured notes are designed to enable investors to make money when prices increase slowly, he explained. Leverage is in place to magnify returns. When returns are small, the chances of outperforming the underlying are greater.

“Volatility tends to work against that strategy. You’d benefit as volatility declines, which is perhaps why this is a little bit risky given the lack of downside protection,” he said.

“I don’t know if I would buy it, but it’s interesting.”

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, said stocks would probably be a better alternative.

“The underlying is what it is. But you have to have a very specific view on the market to buy this note,” he said.

“You’re selling your upside and really quite close to at-the-money for a bigger pop if there is a little bit of a gain.

“It’s a bit strange to have this view. It’s such a narrow window, although you’re a little bit better off if your basket is up 20% because you’ll get 25%.”

View

Tiemann pointed to the close relationship between housing and interest rates.

“You can make the argument that these stocks will do well if rates remain low,” he said.

“Your Bed Bath & Beyond, D.R. Horton, even SolarCity, they’re interest-rate sensitive stocks.

“So basically, what this structure says is housing is going to do OK but not great.

“I always think there are much more straightforward ways to invest. If you don’t think it’s going to do that great, don’t take the risk. And if you’re bullish, you can always buy the underlying outright and trade it accordingly. If there is a big move, you’ll get the full upside. If it goes nowhere, you can sell it whenever you want. There is no issue with liquidity if you own the stocks.

“I’m just not sure why it would make sense to use something like that.”

The notes (Cusip: 61761JF95) priced on Thursday.

Morgan Stanley & Co. LLC is the agent.

The fees are 2.4%.

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