Morgan Stanley’s jump securities on indexes offer double-digit premium in toppish market

By Emma Trincal

New York, July 8 – Morgan Stanley Finance LLC’s 0% jump securities with autocallable feature due Aug. 2, 2024 linked to the worst performing of the Dow Jones industrial average, the Nasdaq-100 index and the Russell 2000 index provide an alternative to a classic autocallable contingent coupon note (known as “Phoenix”) in paying a higher return paid upon early redemption.

The notes will be called at par plus an annual premium of 10% to 12% if each index closes at or above its initial level on any quarterly observation date after six months, according to an FWP filing with the Securities and Exchange Commission. The exact premium will be set at pricing.

At maturity, if all indexes finish above their initial levels, the payout will be 30% to 36%.

If the worst performing index finishes below its initial level but at or above its 70% downside threshold level, the payout will be par. If the worst performing index finishes below its downside threshold level, investors will be fully exposed to the decline of that index from its initial level.

Equity exposure

“It’s tied to all U.S. stocks, so the underlying is not bad. I mean there is some correlation between the indices,” said Steve Doucette, financial adviser with Proctor Financial.

“But I’m not sure the timing is right.”

He was referring to investments in autocallable notes in general.

“I like autocalls but not when the market is at all-time high like it is now.

“The 10% to 12% is a nice call premium. But is a 70% barrier sufficient? Who knows? Any one of those indices could drop 30% in three years,” he said.

Doucette said one of his notes was just called. But he was not sure what to do with the proceeds.

“It’s part of our fixed-income bucket. If we roll it, do we want to give it the equity exposure at this point?” he said.

Coupon versus premium

Doucette said the structure was “fine,” but he noted the difference from most autocallables seen in the market.

The notes fall into the “snowball” structure category, which, unlike the common Phoenix autocall type, pays a call premium when the call is triggered at the initial level strike. Since the hurdle for payment is higher than the contingent coupon barrier of a regular Phoenix autocall, situated below par, and since snowball investors are not able to collect the coupon while still holding the notes, the call premium in a snowball is generally more generous than the contingent coupon in a Phoenix autocall.

Another reward snowballs offer is the so-called “memory” feature allowing investors to cumulate previously missed premium when the notes finally get called.

Asked whether he favors the snowball structure over the Phoenix type, Doucette said that: “I like being able to collect the contingent coupon along the way. It acts as a buffer. That’s the way I would approach it. The key is to find out how much return you give up compared with the call premium.”

Bull run

Doucette said current market peaks raise the concerns of a pullback.

“The market is driving everything up. Not because of the fundamentals or the value of an asset. People are upbeat about the economy, and they believe in the Fed put. People say: as long as the Fed continues to flush the market with liquidity, there’s no real risk on the downside. That’s why some assets have gone through the roof. But how long is it going to last?

“I’m a fundamental, value type of guy. When you keep on hitting record highs, you want to get more protection.”

For Doucette, a 70% barrier over three years was probably not enough.

“If I had to change the note a little bit, I would probably bring the barrier down and give up a little bit of premium,” he said.

Doucette, who has been buying autocallable notes in the past, has become more hesitant to use them today.

“I prefer leveraged notes with a straight buffer or a very deep barrier – something where you can still capture some upside but with a reasonable amount of protection on the downside,” he said.

Core portfolio

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the notes.

“These are three indices I would hold in my core portfolio anyway. So, I’m comfortable with the underlying,” he said.

“The market has been very bullish. It’s prudent to have a downside protection in this environment. That’s when structured notes can really be helpful.

“The premium is attractive relative to my return expectations. I don’t think the market is going to generate that type of return on an annual basis for the next three years.

While Medeiros would get exposure to all three indexes as buy-and-hold positions for his core portfolio, he would expect the notes to have a short duration.

“That would be OK to be called.

“The premium should pay you more than the market. Getting called is the most likely scenario. It would also be a positive outcome,” he said.

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on July 30 and settle on Aug. 4.

The Cusip number is 61773FFJ7.

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