Morgan Stanley’s 10-year trigger gears on S&P 500 index show unusually long tenor

By Emma Trincal

New York, July 6 – The 10-year maturity seen on Morgan Stanley Finance LLC’s 0% trigger gears due July 18, 2030 linked to the S&P 500 index illustrates how challenging it has become for issuers to price uncapped leveraged returns without extending the tenor. And while it is possible to use the long tenors to eliminate the cap, investors are not necessarily motivated to make such long-term commitments.

If the index return is greater than zero, the payout at maturity will be par of $10 plus 1.5 times to 1.602 times the index return, according to an FWP filing with the Securities and Exchange Commission.

The exact upside gearing will be set at pricing. Investors will receive par if the index declines by 35% or less and will lose 1% for every 1% decline of the index from the initial level if the index falls by more than 35%.

Dividends

“I wouldn’t be overly inclined to do such a long-term note,” said Chandler Ferguson, wealth adviser at Quest Capital Management.

“You’re giving up 10 years of compounded dividends.

“If it was a shorter tenor, I would be OK with it.

He added that uncertainty remains high for the next two or three years. But for an investment timeframe of seven years and longer “the index performance should be positive at the end, not negative.”

Tenor and protection

If Ferguson elected to invest over a 10-year period, which, he said is not the case, he would elect to get more leverage and less protection.

“To my knowledge there haven’t been 10-year periods giving you a negative return and certainly not a decline over 35%.

“So, getting more upside would be the priority since you are losing so much in dividends.

“But I wouldn’t go that far anyway.

“Giving up 10 years’ worth of dividends would not be an option for us. You’d be better off owning the index directly,” he said.

The same terms with the same barrier on a five-year would be fine, he noted.

“It always depends on what the client’s motivation is. But a five-year with a 35% barrier would be pretty attractive,” he said.

Tough times

A sellsider said the long-term tenor was a recent trend resulting from increased pricing constraints due to the bull market. It was not reassuring in his view.

“Low rates, low vols, high market prices.... what’s the world coming to?” he said.

A market participant offered a similar explanation.

“I haven’t priced this deal. I’m not sure I really want to,” he said noting that the options may be limited for the structurer.

“Funding as well as rates as well as volatility have just dried out considerably since the Fourth. We’re on for a dull summer.”

Every summer is showing the same seasonal pattern, he noted.

“Most of New York is in the Hamptons, that’s why.”

The “season for the Hamptons” however started unfortunately earlier this year due to the lockdown, he added.

“Once we get past Labor Day and closer to the Elections, volatility will come back up. But right now, the only lever you have for pricing structured notes is the tenor.”

Dividends are used to purchase the options. Longer tenors give issuers more pricing power, which helps pricing when volatility does not provide enough premium.

“Until volatility levels come back up, you’ll have those long-term notes,” he said.

Funding rates are another obstacle.

“Corporate spreads have come back in after widening in March and April. There are not many ways left to provide attractive terms besides longer tenors,” he said.

Alternate options

Still, for investors willing to cap their upside or take some risk (or perceived risk) on the downside, options are available.

The use of a geared buffer allows for the elimination of the barrier while shortening the term, he explained.

Geared buffers may be safer than barriers in some cases, but investors tend to dislike having leverage on the downside, according to interviews with buysiders. Agreeing to a geared buffer may be viewed as an unacceptable condition for some registered advisers who would rather have a deep barrier or a hard buffer.

Using a different and more volatile underlying than the S&P 500 index can also help.

This market participant pointed to a three-year BNP Paribas note set to price this week tied to the SPDR S&P Biotech ETF. The payout at maturity is 3x the gain up to a 46.66% cap. Investors will receive par if the fund falls by up to 20% and will lose 1.25% per 1% drop beyond 20%.

“There is a cap, but it’s a high cap,” the source said.

On a compounded basis the annualized maximum return is 13.6%. It can be achieved if the index goes up by less than 5% a year.

“For someone who wants to play the sector, it’s a good return,” he said.

“The biotech fund is volatile. But both tech and biotech stocks have rallied quite a bit.”

In order to avoid extended maturities, investors will have to tolerate caps.

“We’ll see leverage to cap in the three- and four-year space. As long as they’re getting 12% per annum or better, I don’t think it’s a deal-breaker for people.”

In the past three months, several leveraged uncapped deals priced with five-year terms, according to data compiled by Prospect News. To be fair, the products were not just tied to the S&P 500 but often to one (or even two) additional indexes, the payout being set up as worst-of. Other times, the sole underlier was a sector ETF displaying a greater level of volatility than the equity benchmark.

But 10-year maturities are still rare. Typically, these tenors are seen with rates-linked notes or with equity-based products, which are not principal-at-risk products.

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley and UBS Financial Services Inc. are the agents.

The notes (Cusip: 61771C557) will price on July 17 and settle on July 21.

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