Morgan Stanley’s $435,000 trigger jump securities on MSCI EM, Stoxx offer attractive upside

By Emma Trincal

New York, Aug. 31 – Morgan Stanley Finance LLC’s $435,000 of 0% trigger jump securities due Sept. 1, 2026 linked to the least performing of the MSCI Emerging Markets index and the Euro Stoxx 50 index can enhance returns via a digital payout without limiting the upside participation, a feature financial advisers said was compelling. But they raised concerns about the underliers, the risks associated with uncorrelated assets in a worst-of payout and the cost of the deal.

If each index finishes above its initial level, investors will receive at maturity the greater of par plus the return of the worst performer or par plus the 55% upside payment, according to a 424B2 filing with the Securities and Exchange Commission.

If the worst performer declines, but finishes above its 70% downside threshold level, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the lesser performing index from its initial level.

Jump, value plays

“You’re losing about 10% in dividends over five years on a compounded basis. In addition, the 4.25% fee is high. So, we want to keep this in mind and make sure the note works,” said Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management.

Some aspects of the structure were attractive, however.

“The 55% minimum return, that’s about 10% a year compounded...It’s a nice number. It’s close to the historical rates of return for these benchmarks,” he said.

The underlying indexes are attractive from a valuation standpoint, he added.

So far this year, the performance of the MSCI Emerging Markets index is flat, and the Euro Stoxx 50 index has gained 11.6%. The S&P 500 index in comparison is up 20.4% for the period.

“Both indices have been underperforming relative to the U.S. not just this year but over the last five years or so,” he said.

“So, it’s probably a good time to invest in those indices because they’re relatively cheap compared to the U.S.”

Low correlation

But Foldes also noted some negative points, which would preclude him from investing in the notes unless he would be able to renegotiate the terms.

“Now here is the bad news. First, it’s a five year. We don’t love five-year notes,” he said.

“Second we don’t necessarily love worst-of. What you have here is a worst-of with two indices that are not married to each other.”

The five-year coefficient of correlation between the two underlying is 0.75. In comparison, the S&P 500 index and the Dow Jones industrial average have a 0.96 correlation.

“One of the two indices is Europe. The other is primarily Asia. Those are pretty diverse indices.

Four Asian countries – China, Taiwan, South Korea and India – have combined a 75% weighting in the MSCI Emerging Markets index.

“You could have a situation where one of these indices is substantially higher than the other.

“I don’t mind a worst-of when there is a really high correlation, which is not the case here,” he said.

Strengthening the upside

Finally, Foldes objected to the 70% barrier seeing in this protection a misallocation of the embedded options budget, which could be of better use on the upside.

“Given the fact that these are equity indices, it’s pretty unlikely that over a five-year period you would be down 30%. Having a 30% barrier is expensive and probably unnecessary,” he said.

If he was to discuss the notes with the issuer, Foldes said he would probably seek to eliminate the barrier altogether while keeping the same duration. In exchange, he would look for either one of the two solutions: either increasing the minimum return or adding leverage to the uncapped return above the 55% strike.

The second option is not very common, he conceded. But he would be willing to remove the entire downside protection, keep the minimum return and length of the notes as they are in order to bring leveraged participation above the 55% mark while keeping the return uncapped.

“It’s a question to ask Morgan Stanley. And why not?”

“That’s what I would be looking for,” he said.

In conclusion, Foldes said “there are a lot of things to like” in the note such as the minimum return and uncapped exposure.

“But there are also things that I don’t like about it. Some changes would be necessary to mitigate those negative aspects.”

Concentration

Another financial adviser expressed concerns with the choices of the underlying, saying they are both risky for different reasons.

“The Euro Stoxx 50 is too concentrated compared to the MSCI Emerging Markets,” this adviser said.

The MSCI Emerging Markets index has 1,400 components.

“On the other hand, the Emerging Markets index has a heavy exposure to China,” he said.

China represents 34.6% of the index, according to an MSCI fact sheet.

The top four holdings are Taiwan Semiconductor Manufacturing Co. Ltd., Alibaba Group Holding Ltd., Tencent Holdings Ltd. and Samsung Electronics Co. Ltd.

“Those four big boys alone, that’s almost 20% of the index,” he said.

With a country like China making more than a third of the index, investors should try to assess political risks.

“Is there a chance that China will make good on its threat to invade Taiwan? If that happens, it would have a big impact on the index performance,” he said.

Dividends

The most interesting part of the structure is the upside payout, he noted.

“Over a five-year time, there’s a fairly good chance that both indexes will be up. On average the market is up two out of three years. I think you’re good to go.

“Obviously you’re giving up something starting with dividends. Both are higher than the S&P, especially the Euro Stoxx,” he said.

The Euro Stoxx 50 index yields 2.17% and the MSCI Emerging Markets, 1.48%. The dividend on the S&P 500 index is 1.27%.

“But you’re getting at least 55%. That’s a pretty robust return over five years.

If concentration is one risk, volatility is another one, he said.

“Almost by definition, the emerging markets one is the most volatile. You have to take that into consideration,” he said.

But volatility can be felt on the upside too.

“I love uncapped. I’m very big on uncapped. It’s a great way to be able to keep pace with the index,” he said.

Fee, single asset

The only concern this adviser had with the note was on the downside.

“I don’t expect the market to be down 30% in five years, but that’s a possibility. The problem is if one index goes up and the other down. Assume you don’t hit the barrier and at maturity you get your money back and that’s it.

“After five years, especially if the other index is up, that’s a pretty depressing idea.”

The structure would be more attractive if the fee was lower, he said.

“4.25% is very high. Think about it: we can get ETFs with fees of less than 5 basis points.”

If he had to “restructure” the deal, this adviser would eliminate the worst-of payout.

“I’d be interested in doing the notes on the emerging markets index by itself. I don’t really like the Euro Stoxx 50,” he said.

“Yes, the emerging markets index is volatile, but the growth prospects are much better than the Euro Stoxx.”

Good overall

Despite those negative points, this adviser said that overall, the structure was “pretty good.”

“If the index is up in the low single-digits, you beat the index. If it’s down slightly, you beat the index. If it shoots the lights out, you participate.

“The only thing you have to worry about is the low correlation between the two indexes, one going up and the other, down.

“It’s not perfect, but it’s a decent offering. You could probably use it as a complement to an active international allocation,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Tuesday.

The Cusip number is 61773FKV4.

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