Morgan Stanley’s autocallable jump notes on S&P 500 Daily show high hurdle, modest premium

By Emma Trincal

New York, Jan. 8 – Morgan Stanley Finance LLC’s 0% jump notes with autocallable feature due July 31, 2026 linked to the S&P 500 Daily Risk Control 10% USD Excess Return index present a mixed structure combining an autocallable payout with upside participation if the notes mature. Moreover, the longer-dated product offers full protection against any market decline.

Yet, the way in which the call threshold level is “jumping” throughout the life of the notes made advisers uneasy.

The notes will be automatically called at par plus an early redemption premium of 6% per year if the index closes at or above the applicable redemption threshold on any of the first seven annual determination dates, according to a 424B2 filing with the Securities and Exchange Commission.

The redemption threshold is 103% of the initial index level for the first determination date and steps up by 300 basis points each year to a redemption threshold of 121% of the initial level for the seventh determination date.

If the notes have not been called, the payout at maturity will be par plus any index gain. If the index finishes flat or falls, the payout will be par.

Keep it simple

One buysider complained about the intricacies of the payout.

“There are a lot of moving parts,” said Tom Balcom, founder of 1650 Wealth Management.

“Try to explain these terms to a client. I see notes every day and I would find it challenging to explain the step up.

“You’re dealing with a lot of complexity.”

Balcom noted that on a much shorter duration, investors in T-bills were getting nearly half of the 7½-year notes’ call premium. The one-month Treasury bill yields 2.41%.

“You’re doubling the yield for a lot of risk and complexity. With your seven-year autocallable note, you’re competing with the risk-free rate over one-month,” he said.

Balcom said that clients want “simplicity” when presented with a structured note as a potential investment.

“They don’t want all those bells and whistles. They want to know: market is down, I lose this...market is up, I get that. It’s got to be almost simplistic,” he said.

Low premium

Jerry Verseput, president of Veripax Financial Management, said he has invested in similar structures before. He did not object to the step up or the long duration. He also saw the benefit of the full protection. But the terms in his view were unattractive.

“I guess it’s for an investor worried that we’re entering into a recession. So the principal-protection is the main selling point.

“But the 6% a year premium is really low if you’re using it as a substitute for an S&P 500 holding.

“It seems overly conservative to me.”

Spread

Verseput identified another problem: the tight spread between the call threshold and the accumulated call premium.

For instance, getting the 18% premium if the notes get called on the third determination date would require that an index growth of at least 9% during that the three-year timeframe.

“The spread between the call trigger and the maximum return is too narrow. It’s a high hurdle and the call premium is not even that high,” he said.

Comparison

But Verseput liked the idea of a long-term, principal-protected autocallable note with increasing call threshold levels.

In October, he said he purchased six-year Goldman Sachs Bank USA certificates of deposits linked to the Motif Capital National Defense 7 ER index. The notes pay an annual call premium of 9.5% with an initial call threshold of 101.5% increasing each year by 1.5%.

“The hurdle was much lower and the yield much juicier. On top of that, I had the FDIC insurance against credit risk,” he said.

The appeal of the CD could be measured by the width of the spread between the call trigger and the capped return, he said.

The wider the spread, the easier it is to get called or to get a decent return or both, he explained.

With the Morgan Stanley note, the annual redemption threshold “jumps” by 3% a year while the call premium increases by 6%, giving it a 3% spread.

On his CD, the spread between the 9.5% annual return and the 1.5% step up each year was 8%, he noted.

“I got an 8% spread, which is much more significant than 3%. 3% is too narrow of a window,” he said.

Participation

Regardless of the deal, the structure offers upside participation at maturity, but this feature is not as compelling as the full downside protection, according to this adviser.

“If you haven’t been called six years in a row, it’s unlikely that you’re going to be making the last threshold,” he said.

This assumption was reinforced by the nature of the underlying, which is designed to smooth wild price swings.

The S&P 500 Daily Risk Control 10% USD Excess Return index provides investors with exposure to the U.S. equity markets through the S&P 500 Total Return index while attempting to reduce large fluctuations in the underlying index’s performance through the use of a volatility target.

“It’s a very conservative investment with limited upside potential,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Jan. 28.

The Cusip number is 61768DXG5.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.