Morgan Stanley’ eight-year trigger PLUS with no cap on indexes provides pure bull play

By Emma Trincal

New York, Sept. 22 – Morgan Stanley Finance LLC’s 0% trigger Performance Leveraged Upside Securities due Dec. 31, 2025 linked to the lesser performing of the S&P 500 index and the Russell 2000 index employs the premium generated by a worst-of structure to provide uncapped leverage over a long tenor, an attractive formula for a bullish investor, said Suzi Hampson, structured products analyst at Future Value Consultants.

If each index finishes at or above its initial level, the payout at maturity will be par of $10 plus 200% of the gain of the worse performing index, according to a 424B2 with the Securities and Exchange Commission.

Investors will receive par if either index falls but by no more than 50% and will be fully exposed to any losses of the worse performing index if it finishes below the 50% trigger level.

Different

“This product is a worst-of, but it’s a different kind of worst-of,” said Hampson.

“Instead of an autocallable reverse convertible you get unlimited upside with double gearing. That is not very common. Most of these products are designed for income, not growth.”

The eight-year maturity was also unusual.

“It’s much longer than average,” she said.

Investors in the notes would seek leveraged market exposure to the U.S. market.

“Rather than having exposure to the Russell or the S&P, your exposure is the worst-of the Russell and the S&P. It is not the indexes bundled in a basket and it is not one index only. You have this extra risk,” she said.

The risk induced by the worst-of payout was somewhat lessened by the high correlation between the two U.S. equity benchmarks, she said.

“That’s a good thing. If they move together you reduce the risk,” she said.

Unlimited upside

The worst-of structure was the feature that allowed the issuer to uncap the return while providing the leverage.

“You wouldn’t expect to see a double gearing product on a single asset without a cap,” she said.

“And you wouldn’t get a 50% barrier either.”

The product was designed for bullish investors who needed U.S. equity allocation.

“Rather than buying the S&P and the Russell 2000 separately you put all your money in the worst one. You would do that for the high gearing primarily.

“You’re getting the worst of those indexes, but at the same time you also have a 50% barrier.

“It’s a way of reducing volatility. You decrease the chances of losing money but you still have the potential for big losses.”

Stress tests

Future Value Consultants provides stress test reports on structured notes. Each report contains 29 sections, which users can choose from.

One of those, the capital performance tests table, shows the probability of outcomes and the average payoffs. Leveraged notes have simplified possibilities compared to autocallables for instance. In this product only three scenarios may happen: the notes return less than capital, return exactly capital, and return more than capital.

Each test is displayed across five various market assumptions. The base-case or neutral scenario is derived from the risk free rate and dividends and is the general standard for pricing. The other four scenarios, which are offered to guide investors having a particular market outlook, are bull, bear, more volatile and less volatile.

Bull assumption

Hampson looked at the bull scenario of the table as it is the assumption that’s the most favorable to the product.

“Investors want to see what happens based on their own market view. The bull scenario is the most appropriate,” she said.

Investors in this context have an 82% chance of getting more than capital. The average payoff for this outcome would be 246.4%.

“Everything is bullish in there. You have no cap, double gearing and a long investment period, which compounds returns over time,” she said.

The bull assumption lies on a conservative growth assumption of 6.8% per year for the Russell 2000 index and 5.8% for the S&P 500. The same is true of the bear scenario, which shows a rate of decline of only 5% a year.

“We want to avoid extreme scenarios in order to facilitate the simulation and make comparisons between products. These subdued growth assumptions are part of our methodology.”

Given those principles, the simulation shows that there is only a 14% chance of generating a positive return in the bear scenario. When it happens, investors may expect an average payoff of 136% for the term.

The possibilities of breaching the barrier are limited to 3.32% in the bull market but can be as high as 42% in the bear scenario. Given how low the barrier is however, once it breaches losses are extremely high, she noted: 66% on average in the bull and 75% in the bear scenario.

Back tested analysis

This negative outcome just does not exist when looking at the back tested tables for the past five years, according to another table which presents back tested analysis over the last five, 10 and 15 years.

“If you held this product over the past five years you would receive a positive return on every occasion,” she said. Chances of gains decrease a little bit over the last 10 years with a 79% probability. But going back to the years that preceded the financial crisis the chances of getting a positive return increase again to 86% over the past 15 years.

In those two last timeframes (10 and 15 years) the average loss is about 50%, which is much less than the hefty losses seen in the simulation, she noted.

“The main difference between the simulation and back tested results is the frequency of the breach and the amount of losses,” she said.

The back tested results suggest how well the product can perform in a bullish environment.

“This note gives investors the potential for good growth. It’s an interesting use of the worst-of, which we don’t typically associate with gearing,” she said.

“For investors who don’t intend to trade in and out of their investment and who can hold the notes for a long time, this offers an interesting way to be bullish on the market.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will settle on Sept. 26.

The Cusip number is 61768CQB6.

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