Morgan Stanley plans S&P 500-linked protected notes; high cap may be optimistic, adviser says

By Kenneth Lim

Boston, Aug. 26 - Morgan Stanley's planned principal-protected notes linked to the S&P 500 index have an extremely high return cap, but investors should be aware that they may not get such a high return, an investment adviser said.

Morgan Stanley plans to price zero-coupon notes due March 27, 2015 linked to the S&P 500.

At maturity, investors will receive par plus any gain in the index, subject to a maximum total payout of 150% to 160% of the principal. Investors will get at least par.

The exact cap will be set at pricing.

High cap

The note's return cap is extremely high, the adviser said.

"Usually they give you a lower cap but maybe a bit more on the participation aspect," the adviser said. "This one sets the cap at 50% to 60%, which is about 7.5% to 9% annually, which is much higher than any CD you can find in the market and slightly higher than most high-grade corporate debt, which is maybe around 5% right now depending on the company."

But the adviser said investors should consider what the high cap means before buying the product.

"The S&P is now around 1,000, so if you're aiming for a 50% to 60% increase in the S&P over 5.5 years, you're looking at going back to and even better than the peak of the S&P before the economic crisis struck in 2008," the adviser said. "So you're talking about going from we're just coming out of the bottom of a massive recession to better than the previous peak in about 5.5 years. That's pretty optimistic."

Considering alternatives

If the cap is not reached, the product may not be as attractive as the high cap suggests, the adviser said.

"If I think that at the end of the day I'm only going to get 6% per year, for example, maybe I can do better with high-grade corporate debt which has the same kind of credit risk as something like this but I get a fixed coupon so I don't have to worry that the S&P doesn't do well and I underperform a CD," the adviser said.

But if investors are highly optimistic about the equity index, they might also want to consider slightly riskier products, the adviser said.

"If I think the S&P is going to be at 160% of where it is today in 5.5 years, what should I think the chances are that I need full principal protection?" the adviser said. "If I think it's going to end at 160% but I think I need to buy protection in case it's below 100%, then either I don't really know what I'm doing and I shouldn't be taking a gamble like this or I should be looking for something that has better upside returns but less downside protection."

If the product were a certificate of deposit, however, it would be much more attractive, the adviser added.

"The difference is a CD is FDIC insured, so I'm not exposed to the credit risk of the issuer," the adviser said. "So from a risk perspective, this would be better than corporate debt, and from a return perspective it could be better than a straight CD."

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