Morgan Stanley's jump securities linked to iShares MSCI Brazil offer big upside potential

By Emma Trincal

New York, April 1 - Morgan Stanley's upcoming jump securities linked to the iShares MSCI Brazil index fund may appeal to investors seeking a "high" return on the Brazilian equity market without being particularly bullish, said Suzi Hampson, structured products analyst at Future Value Consultants.

The 0% jump securities will mature April 24, 2012, according to a 424B2 filing with the Securities and Exchange Commission.

If the exchange-traded fund's final share price is greater than the initial share price, the payout at maturity will be par of $10 plus 32% to 37%. The exact upside payment percentage will be set at pricing.

If the final share price is less than the initial share price, investors will be fully exposed to the decline.

Jumps on the rise

"Jump securities are among the most popular product types we have at the moment along with autocallable notes," said Hampson.

"The idea of a fixed return appeals to people, especially with a 34.5% potential return, which is quite high."

Hampson took the midpoint of the 32% to 37% upside percentage payment range to determine the 34.5% hypothetical level.

Such a payout, she said, would be the equivalent of a 15.97% return per year.

Hampson said that the "jump" structure is somewhat hybrid. Those products share common traits with income products, such as reverse convertible notes. Yet, they may best fit into the growth category, she said.

Looks like income...

"Jump securities offer a fixed return usually paid if the index stays the same or rises. They can offer better potential returns than income products as they are not guaranteed payments but perform well under similar scenarios, for instance, when the underlying index remains flat," she said.

"With these notes though, you need your index not to fall in order to get your payout; in a reverse convertible structure, you will get your coupon no matter what," she said. "That's why jump products are not income products despite some similarities."

...but it's growth

The jump securities may fit into the growth category better, Hampson said, adding that "obviously not as a participation product."

But jump securities have the characteristics of growth products because payment is only received once, at maturity, she said. In addition, the payment is triggered contingent upon particular moves of the underlying.

With this structure, the trigger will be an index that "ends at least at initial level," she said.

Investor's profile

Hampson said that the jump securities linked to the iShares MSCI Brazil would probably appeal to those looking to invest in the fund but with a preference for the payout profile of the notes rather than a direct investment in the fund.

"This product would attract those who don't think the [fund's] return is going to exceed 34.5% in two years," she said.

In addition, investors would have to be willing to lock away their funds for two years, she noted.

Inversely, the product would not be interesting for the "really bullish" investors. Those who see the Brazilian equity market posting more than a 34.5% gain in the next two years would prefer not being capped by the notes' payout, she said.

Since April 1, 2008, the MSCI Brazil lost about 6%.

In addition, some investors may prefer to invest in the fund directly for the dividends and the absence of credit exposure to the issuer, she said.

High risk

Given the underlying and the payout structure, which lacks any form of downside protection, the product is "quite risky," said Hampson.

Its riskmap, which is Future Value Consultants' rating that measures the risk associated with a product on a scale from zero to 10, is 7.71.

"This riskmap is on the riskiest side of the scale," said Hampson. "The risk is high because there is no downside protection."

Her estimate is based on Future Value Consultants' "rating versus riskmap chart," which compares riskmap and overall ratings of the firm's 50 most recently rated products encompassing all different structures.

"Each time principal is at risk, whether it's a leveraged note or a product like this one, you could expect to have a buffer. The absence of the buffer means that there will be a higher coupon but obviously more risk. However, there is no more downside risk here than there is in a direct investment into the fund," she said.

Extreme outcomes

This riskmap is reflected in the probability of losses and return outcomes investors should expect, which Future Value Consultants calculates using a Monte Carlo simulation. The performance is modeled based on a series of parameters, which include volatility, dividends and interest rates, among others.

The simulation shows that there is a 51.4% chance that the fund will end at or above its initial level.

On the other hand, there is a 48.6% chance for investors to lose more than 5% of their principal, she said.

Average return

"The high probabilities of losses and returns feed into the return rating," said Hampson.

Return rating is Future Value Consultants' indicator, on a scale from zero to 10, of the risk-adjusted return of the notes. It is 4.68 for this product.

"It's fairly average," said Hampson, based on a chart comparing this score with 50 other products in all categories the firm recently rated.

"The high probability of losing so much capital is the reason for the return rating. The fact that it is not lower is because of the attractive payout, which has a probability of 51.4% of being earned," she said.

Overall rating

The overall rating, on a scale from zero to 10, is Future Value Consultants' opinion on the quality of a deal.

This product overall score is 5.84.

The rating takes into account costs, structure and risk-return profile. It is an average of three scores weighted 40% to the value score, 40% to the return score and 20% to the simplicity score.

Hampson said that based on the rating versus riskmap chart, "the overall seems to be higher than the majority of products."

The product has a high simplicity rating of 8, which measures on a scale from zero to 10 the product's easiness to be understood.

Value rating, which measures on the same scale how much money the issuer spent directly on the assets versus fees and margins, is low at 5.91, said Hampson. But things may change, she said, as the pricing remains indicative.

The securities are expected to price and settle this month.

Morgan Stanley & Co. Inc. is the agent.

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