Morgan Stanley’s PLUS due 2019 with no cap linked to Euro Stoxx 50 index will appeal to bulls

By Emma Trincal

New York, March 17 – Morgan Stanley’s 0% Performance Leveraged Upside Securities due May 23, 2019 linked to the Euro Stoxx 50 index are designed for bullish investors seeking to capture the full upside of the European equity market, which many say is attractively valued relative to the United States and set to reap the benefits of a recent monetary stimulus in the euro zone.

The payout of the notes at maturity will be par plus 175% of any index gain, according to a 424B2 filing with the Securities and Exchange Commission. There is no protection feature on the downside.

While the uncapped and leveraged upside will satisfy the most aggressive bulls, the full downside exposure coupled with the slightly over four-year holding period will require on the part of investors strong conviction in a European bull market.

No cap

“Fifty months is a little bit on the long side. It is beyond our 36 month limit,” said Steve Foldes, vice chairman of Evensky & Katz / Foldes Financial Wealth Management.

“But the fact that there is 1.75 leverage on the upside is nice, especially since it’s uncapped. If the asset class takes off, you’re getting the full upside.”

Credit risk always increases with duration. In this case, however, such risk is not his chief concern.

“Morgan Stanley has its own issues in respect to credit quality. It’s always a consideration. But we have had no problems with Morgan Stanley. We’ve owned it over a period of years. Obviously you need to be careful,” he said.

Having no downside protection at the end of the term is not attractive. However, the low valuation of the asset class helps.

Relative value

“Valuation is a consideration when you invest in Europe,” he noted.

“Given the modest results of the European market over the past year or so, there is a level of ‘cheapness’ of European equities versus U.S. equities,” he said.

The Euro Stoxx 50 index dropped 9.7% last year while the S&P 500 index posted a 13.5% gain.

“Europe is a good place to be allocated,” he said.

“If you’re looking for attractive valuation, Europe seems to have that and should be part of a diversified portfolio.”

The QE question

The recent move of the European Central Bank into its own “quantitative easing” program should also help equity markets in Europe.

“The ‘QE’ factor is important. The ‘don’t fight the Fed’ saying goes for the ECB as well I suppose. QE has proven to be a positive for the U.S. stock market. It could very well be the case in Europe as well,” he said.

But the real rationale behind a bullish bet is the notion that a turnaround is due for European stocks, which have significantly lagged the U.S. markets especially over the past six months. The Euro Stoxx 50, up 3.5% this year to date, is already outperforming the S&P 500 by 2.75 percentage points.

“Often times, you see a pretty significant bounce back, so it makes sense to hold the Euro Stoxx in the portfolio,” he said.

“Notwithstanding the lack of downside protection, as the index is coming off the down year of 2014, having 1.75 leverage is a good thing and having an uncapped exposure is also a good thing, especially if this market starts to rally this year.”

Trade-off

Assessing the pros and cons of the structure, he said that the “negative” is the 50-month maturity while the “positive” is the “levered uncapped” return.

While the absence of any barrier or buffer is also a negative, Foldes said that it could be explained and even be seen as an acceptable compromise.

“Obviously, it’s nice to have downside protection, but in this case given the starting point, on the heels of a significant market decline, with Europe curing its ills with QE, depending on what it does with Greece, it is likely that European stocks will be higher four years from now,” he said.

“We’re starting at a lower level. The upside is nice. If you have a very good move, you’ll fully participate in that.

“Yes, it would be nice to have some downside protection.

“In this instance, I’d rather have the uncapped 1.75 leverage than a modest downside protection.”

Market risk

For Dean Zayed, chief executive officer of Brookstone Capital Management, the downside protection carries more weight for the more cautious investor.

“I like the leverage in this note but would likely not buy this for a client. The lack of protection is concerning, especially since it is a point-to-point structure with no interest paid until maturity,” Zayed said.

“At this late-stage bull market, I would insist on some protection in the notes I purchase and ideally would do so in a shorter term than four-plus years.”

The recent start of the ECB’s bond-buying program will likely have an impact on the European stock market, although its magnitude remains unknown.

“I do think that European QE can boost European stocks, hence this note can be attractive for a [strong] Euro bull not concerned with protection,” he said.

“In the end though, it is difficult to tell if European QE will have the same impact that ours did on stocks ... a tough bet without protection in my opinion.”

Another one

Morgan Stanley announced a second leveraged uncapped deal based on the same index, 0% airbag performance securities due March 31, 2025. In exchange for more upside leverage – to be set between 2.10 and 2.20 times – and a 20% downside geared buffer with a 1.25 multiple, investors will have to accept a much longer duration, according to a separate SEC filing.

“I wouldn’t buy a 10-year note even if the terms are better. It’s great to have a buffer, it’s great to have more leverage, but the 10-year term is a non-starter for me,” said Foldes.

“If I were to pick between these two notes, it is a no-brainer to pick the one with the shorter term. Ten years today seems like an eternity, especially given the rapidity of changes in the global markets,” said Zayed.

“Although the shorter-term note has no protection, I see it appealing to investors that are very bullish on the Euro Stoxx and therefore not so adamant about having some downside protection.”

Morgan Stanley & Co. LLC is the agent for the 50-month notes (Cusip: 61764V497). They will price on March 20 and settle on March 25.

For the 10-year notes (Cusip: 61764V505), Morgan Stanley is the agent and UBS Financial Services Inc. is the dealer. They will price March 27 and settle March 31.

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