Morgan Stanley’s $436,000 dual directional jump notes on indexes fit for long-term play

By Emma Trincal

New York, Aug. 9 – Morgan Stanley Finance LLC’s $436,000 of 0% dual directional trigger jump securities due Aug. 4, 2026 linked to the least performing of the Russell 2000 index, the Nasdaq-100 index and the Dow Jones industrial average allow buy-and-hold investors to outperform the market in both directions, an adviser said.

If the least performing index finishes at or above its initial index level, the payout at maturity will be par plus the greater of the return of the worst performer or 37%, according to a 424B2 with the Securities and Exchange Commission.

If the final index level of the worst performer declines, but not below 70% of its initial level, the payout will be par plus the absolute value of the index return of the worst performer.

If the lesser performing index finishes below the downside threshold value, investors will lose 1% for every 1% that the least performing index declines from its initial level.

Rolling periods

Carl Kunhardt, wealth adviser at Quest Capital Management, said he liked the notes because investors could beat the market within a wide range from minus 30% to plus 37%.

He was confident in the protection offered by the barrier.

“I'd be interested in seeing if within a five-year period, any of these indices has ever been down 30%. I don’t think so,” he said.

“Thirty percent is a healthy barrier on a five-year period.”

Three indices

The worst-of added some risk. The riskiest of all would be the small-capitalization benchmark, he noted.

“You would think the index with only a few components, in this example the Dow, would be the most volatile. But it’s not the case,” he said.

“Small caps are the most volatile. Here, the Russell would probably be the biggest mover.”

The use of three U.S. equity benchmarks mitigated some of the risk associated with worst-of exposure, he noted.

Tenor, minimum gain

But for Kunhardt, the tenor of the notes was key.

“The five-year term is your friend. I would have to run the back-testing but again, I really doubt there has been any five-year period when any of the three indices has been down a cumulative 30%.

“So, I’m pretty comfortable with that.”

The barrier and the tenor were not the only positive terms of the notes.

“If you're giving me a guaranteed 37% for the index and a 30% barrier on the downside, those two things make a nice note in and of itself. Now, you're adding the absolute return. Well, that’s nice. I do kind of like it,” he said.

Duration and underlying

Kunhardt clarified his view on longer tenors.

“I typically don't like notes going on five years. but in this case, it helps you,” he said.

“You could find a three-year in the rolling returns when one of those might breach 30% but it's unlikely on a five-year.”

This adviser’s view on longer-dated notes depended somewhat on the type of underlying used by the issuer.

“To be fair, we're not systematically opposed to five-year maturities. This note is a good example. I think it’s reasonable to play longer terms with indices. It's the five-year notes on stocks that we avoid. We're not rolling the dice on stocks for five years when you can't get out of it.”

Liquidity

Kunhardt said that all structured notes have one negative trait in common – their lack of liquidity.

“You get compensated for that. But notes are not liquid. They don’t trade on the exchanges. There’s no secondary market. They tell you the issuer has the option to buy it from you. But if they’re buying it back from you, it’s likely that you’ll get a lot less than what you paid for it.

“There is no practical way to get out of it,” he said.

Kunhardt said that he always brings the liquidity issue to his clients’ attention before recommending a product.

“Before I even get to the structure and the benefits of the note, I tell my clients upfront that we’re not talking about a liquid investment. For some – and it’s rare – that’s the end of the conversation. If it happens, we move on, and I work on finding a suitable alternative for my client with other types of securities.”

But liquidity in this product would not be a major concern in his mind.

“It’s certainly to your benefit to hold it. The note has a lot to offer both on the upside and on the downside,” he said.

Moving parts

Kirk Chisholm, wealth manager and principal of Innovative Advisory Group, was not comfortable with the downside risk.

But he began to point to the “complexity” of the terms. Several elements must be explained to and understood by clients, he said, such as the worst-of exposure, the minimum payment, the one-to-one upside above 37%, the absolute return above the 70% threshold and the consequence of breaching the barrier.

“This is a really complicated product for most retail investors,” he said.

Big downturn

Chisholm did not think the longer duration was an advantage.

“It's a bit challenging on five years, because you're going to have a bear market,” he said.

This adviser does not subscribe to the traditional definition of a bear market, which means price declines of 20% or more from recent highs. In his view and in the current environment, a “bear market” would be more of a 40% to 60% drop because of the extremely high valuations in the U.S. market, which is already the longest bull market in history.

“I prefer to call what’s ahead of us a recession although it’s the market I have in mind,” he said.

“I don't know what the worst-of is going to look like, but I can see the stock market dropping more than half and that’s not going to help the notes.”

Overextended bull

In this context, the barrier had little value, he said.

“I can see the appeal of the product if you expect some volatility ahead and by that, I mean prices falling by 10% to 20%... the normal correction scenarios. But I'm not expecting that at all.

“We are right now at the most extreme market valuation levels ever seen before. If we’re going to have a major bear market as I anticipate, it's going to take more than five years to come back.”

The potential benefits of the upside payout, which consists of the guaranteed minimum return and uncapped exposure, were irrelevant in this overheated market, he noted.

“I don't expect the market to be flat or up in five years. If I had to give it a probability, I would say we have less than a 10% chance for this to happen. Valuations in the U.S. markets are through the roof. We've gone too far.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Aug. 4.

The Cusip number is 61773FKF9.

The fee is 0.25%.

© 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.