Morgan Stanley’s trigger PLUS tied to S&P 500, Russell show eye-catching 10x leverage

By Emma Trincal

New York, Feb. 25 – Morgan Stanley Finance LLC’s 0% trigger Performance Leveraged Upside Securities due Feb. 29, 2024 linked to the worse performing of the S&P 500 index and the Russell 2000 index offer exceptionally high leverage by a factor of 10 times, and the other terms of the notes also caught buysiders’ interest.

If each index finishes at or above the initial level, the payout at maturity will be par plus 1,000% of the gain of the worse performing index up to a maximum return of at least 150% of par, according to an FWP filing with the Securities and Exchange Commission.

If either index falls by up to 40%, the payout at maturity will be par.

If either index finishes below its 60% trigger level, investors will be fully exposed to any losses of the worse performing index.

Good terms

“This seems like a very interesting note. I like it,” said Jerrod Dawson, director of investment research at Quest Capital Management.

“Of course, I always prefer a buffer to a barrier. But a 40% decline is quite a lot. You can play the odds that it’s not likely to go down that much in five years based on historical performance even late in the cycle.”

Dawson compared the downside with a long-only position.

“You’re not worse off on the downside than a naked position and you’re certainly better off on the upside.”

Dawson spoke about the downside first as he always looks at risk initially. But the note was particularly intriguing for the amount of upside leverage it offered, he said.

“Assuming you give up 2% a year in dividends, so 10% over the term. This loss is well offset by the 10x leverage,” he said.

“Worst case scenario the market is flat... let’s say up 2% at the end. That’s your dividend. You’re not worse off than owning the index.

“The optionality is in your favor. Your cap is pretty high and it takes a lot to lose. The leverage is enormous. This type of note plays in the investor’s favor.”

Overpriced benchmarks

Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, also had a positive opinion on the note even though he is not bullish on U.S. equity markets.

“I’m reluctant to invest in U.S. stocks right now because it’s the most expensive out there. You’re starting at a very high point,” he said.

“But this note has some very positive features that help a lot.”

Kaplan started with some historical facts, saying that since the early stages of the stock market in 1790, the market has only been as high as today only twice – in December 1999 and in September 2018, both times ahead of solid declines. His measure was based on the Shiller price/earnings ratio, which is inflation-adjusted terms using several fundamental indicators such as price-per-earnings and price-to-book ratios.

“We are at record highs historically. To me it doesn’t make much sense to buy the U.S. market right now,” he said.

Right tenor

However, the terms of the deal, even for Kaplan who is bearish, were “unusually” attractive.

“I like the length. Yes, five years from now there is always a chance that the market will be lower than today. But there’s also enough time for the market to plunge in bear territory and then recover,” he said.

“Having this huge leverage will help because you don’t need to surpass by a lot.”

The danger of severe bear markets is when investors buy at a high, he explained.

“If you had purchased the S&P in March 2000 at the peak just before the internet crash, you would have had to wait until October 2007 to break even. You would still be lower at that time if you adjust it for inflation,” he said.

Bear proof

Such scenario would be nearly impossible if a bear market, even a severe one, was to happen in the next 18 months to two years as Kaplan anticipates.

“The S&P is at about 2,800 now. Imagine the market drops by two-thirds sometime around the elections. You’re now at 950. You still have three years to recover,” he said.

He assumed in his hypothetical example that the market would triple from its bottom level for the next three years.

“That would take you to 2,850, about 2% from the initial price of entry.”

Without leverage, a bear market can force investors to wait a long time to break even. But the notes would give them an edge with the 10 times leverage factor.

At the end of the five years, investors would receive 10% (2% times the 10x factor) and would be well ahead of the market.

Inflation hedge

In a more optimistic scenario, the notes offer other benefits.

First the cap can be achieved if the worst-performing index is up by a very small percentage of 2.8% a year, which represents a 20.11% annualized compounded maximum return.

In addition, investors anticipating a higher cost of living could use the notes as a hedge against inflation.

“If inflation is up, you’d be ahead in real terms because this thing is giving you 10 to 1 so really it’s not much of an issue,” he said.

“If the market was up 15% over the period, you’d cap out at 150%. Even if we have a 6% inflation rate, or 30% for the period, you’re still well ahead of the game,” he said.

“It’s certainly a very unusual note.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Feb. 25.

The Cusip number is 61768DM51.

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