Morgan Stanley’s digital notes tied to Nasdaq, S&P, Dow to beat sideways market, advisers say

By Emma Trincal

New York, Dec. 7 – Morgan Stanley Finance LLC’s 0% trigger jump securities due Jan. 3, 2028 linked to the worst performing of the Nasdaq-100 index, S&P 500 index and Dow Jones industrial average, in providing a minimum return, uncapped upside and downside barrier, allow investors to outperform U.S. equity benchmarks in a rangebound market, advisers said.

If the return of the worst-performing index is positive, the payout at maturity will be par plus the greater of that index's return and 62.4%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the worst-performing index declines but finishes at or above the 80% downside threshold level and will lose 1% for every 1% that the worst-performing index declines if it finishes below the threshold level.

Five-year tenor

Tom Balcom, founder of 1650 Wealth Management, said the annualized compounded return was “attractive.”

“You get 10% a year on a compounded basis and that’s a guaranteed return as long as the market doesn’t finish negative at the end of the term,” he said.

One caveat was the duration.

“It’s long for our clients. But being able to earn 10% a year for five years with the potential to earn an even higher return if the market is higher, that makes the five years totally fine,” he said.

The downside was relatively well protected, he added.

“If you look at historical returns and five-year rolling periods, there is only a small probability for any of those indices to finish negative,” he said.

Dispersion

The uncertainty created by the worst-of exposure was somewhat diminished by the correlations between the three underlying indexes.

“The only risk is if there’s a laggard. Say one is up much more than 10% a year but not the other two. In that case you only get the 62% return over five years. But I doubt any client is going to be upset about that although some may,” he said.

It would be “more of an issue” if at least one index finished negative. But Balcom downplayed the risk.

“They tend to move in the same direction. Over five years, the chances of one being down are very slim,” he said.

Dividends

The notes would be a particularly good fit for investors betting on a rangebound market.

“If those three indices are flat for whatever reason, your client should be thrilled. That would be the best case really,” he said.

Investors will not earn dividends over five years. The highest “opportunity cost” comes from the Dow Jones industrial average, which pays a 2% dividend yield, the highest rate of the three underliers.

“The 10% digital coupon more than makes up for the loss of dividends,” he said.

Advisers may allocate the notes to different parts of the portfolio. Balcom said he would not use his fixed-income allocation since the principal remains at risk.

“But I can see putting it in the hedging bucket. After all, you do have 20% barrier,” he said.

“This is a note for somebody who is moderately bullish, somebody with a rangebound view on the market.”

No cap

Donald McCoy, financial adviser at Planners Financial Services, also liked the notes provided that investors would be comfortable with the duration.

“It’s definitely a tempting offer in that generally, if you look at five years, you don’t worry too much about the market being down over that timeframe. And you still have a 20% barrier,” he said.

The upside was also advantageous for investors seeking to participate in the U.S. markets.

“There is no upside cap. So, you’ll get at least 62% or more. That’s another plus,” he said.

“You’re not getting paid the dividends but it’s not an issue with the Nasdaq.”

The Nasdaq pays the lowest dividend yield at 0.7%. The S&P 500 index yields 1.7%.

Beating expectations

“If you’re a long-term investor, it looks like an attractive offering,” he said.

“There is no cap on the upside. If the market is going nowhere, you get 62% at maturity. That’s a double-digit performance over the next five years. A lot of analysts and forecasters say you should expect single, not double-digit returns in the next five years for U.S. equities.”

The long tenor and the correlations between the indexes reduced the odds of one index finishing negative.

“For clients with a long-term time horizon, it’s a compelling deal. If all three indices are up, you’re going to get 10% per year. That’s quite above my own expectations,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes are expected to price on Dec. 29 and to be issued on Jan. 4.

The Cusip: is 61774TBM3.

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