Morgan Stanley’s enhanced trigger jump notes tied to three ETFs have thin barrier, sources say

By Emma Trincal

New York, July 27 – Morgan Stanley Finance LLC’s 0% enhanced trigger jump securities due Aug. 1, 2019 linked to the worst performing of the iShares Dow Jones U.S. Telecommunications exchange-traded fund, the Utilities Select Sector SPDR fund and the Consumer Staples Select Sector SPDR fund allow investors to outperform the three sectors in a downturn, but the barrier may be easily breached, making this outcome less likely to happen, sources said.

If each fund finishes at or above its 80% threshold level, the payout at maturity will be par of $10.00 plus the upside payment of $2.42, according to an FWP filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to the losses of the worst-performing fund.

Volatility

A market participant said that the likelihood of getting paid the upside payment of 24.2%, or about 8% a year, is not that high.

“You’re getting 8% a year as long as none of those sector funds drop more than 20%,” he said.

Volatility in the telecommunications, utilities and consumer staples sector is low, he noted.

“If volatility was higher, you could get a higher coupon or you could place the barrier at a deeper level than 20%,” he said.

Unpaid dividends

The 20% contingent protection has to be evaluated based on the dividends. Each underlying sector ETF pays dividends to equity holders, which investors in the notes have to forego.

The issuer used the dividend yields of the three respective funds to price the deal. The market participant estimated the dividend yield on those funds to be at 2.5%.

“All three funds feature high dividends. I would guess it’s a 2.5% yield, or 7.5% over the three years,” he said.

The assumption is accurate. The iShares Dow Jones U.S. Telecommunications ETF has a 1.90% dividend yield, the Utilities Select Sector SPDR fund, 3.27% and the Consumer Staples Select Sector SPDR ETF, 2.37%. The average is 2.51%.

Barrier

“When you subtract the 7.5% dividend from the 20% barrier, your real protection is only 12.5%. That’s not very high,” he said.

Investors may get the 8% annualized return but only if none of the three ETFs drop by more than 12.5%, he noted, taking into account the barrier amount excluding dividends.

“One of the three funds can make you lose the protection,” he said.

“The probability of getting this coupon is not as high as you would think when you look at a 20% barrier.”

Worst of

A financial adviser agreed: the lack of dividends is a drawback. He also stressed the worst-of payout and the barrier as negative aspects of the structure.

“I don’t know how easy it is to sell to a client that worst-of concept. From my perspective, it’s a big problem. It’s probably more for institutional clients because retail clients would find it confusing,” this adviser said.

“I would presume there is no interest or dividend. That’s certainly an issue when you’re comparing this with the ETFs, which are probably among the highest-yielding sectors. That’s a reasonable negative.”

Finally the barrier is insufficient to mitigate risk in an acceptable way, in his view.

“The 20% barrier is nice, but three-year is not really a short-term note. If one of those funds is down two years in a row, you could easily breach the barrier. A buffer would be better. From my perspective, I don’t think the barrier is optimal,” he said.

Morgan Stanley & Co. LLC is the agent.

The notes are guaranteed by Morgan Stanley.

The notes will price on Friday and settle on Wednesday.

The Cusip number is 61766B788.

© 2015 Prospect News.
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