Morgan Stanley’s $1 million jump securities on S&P MidCap 400 seen as fixed income replacement

By Emma Trincal

New York, May 12 – With an unusually long maturity, guaranteed return if the underlying is up and deep downside protection, some advisers viewed Morgan Stanley Finance LLC’s $1 million of 0% trigger jump securities due May 14, 2029 on the S&P MidCap 400 index as a fixed income substitute.

If the return of the index is positive, the payout at maturity will be par plus the greater of the index return and 35%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines but finishes at or above the trigger level and will lose 1% for every 1% that the index declines if it finishes below the trigger level.

Scott Cramer, president of Cramer & Rauchegger, Inc., said he liked the risk-adjusted return of the notes.

“If you’re looking to make an allocation to your medium-term bucket, this is a great way to get upside participation in the S&P MidCap 400 while having a lot of protection. A 55% barrier on an index that’s already down gives you a significant amount of protection,” he said.

The index is nearly 20% off its November high.

Bond proxy

The notes combined the benefits of a minimum return, upside participation and low barrier, he said.

“This is a great proxy to a bond.

“Traditional bonds are going to do horribly with rising interest rates. With this note, you’re not that vulnerable to interest rate movements,” he said.

Investors will receive at least 35% or approximately 4.5% a year on a compounded basis if the index is positive at maturity.

“That’s not bad for fixed income. And you still get the upside without a whole lot of risk,” he said.

Investors in the note just need to be confident the index will not fall by more than 45% at the end, he added.

“Things would have to be pretty apocalyptic if it fell that much seven years from now,” he said.

The note was attractive for its defensive characteristics.

“You can use it in the safer portion of your portfolio and do other things around this,” he said.

The adviser said he was pleasantly surprised with the product based on what he has seen in the market.

“I’ve not liked a lot of structured notes because the risk I thought was skewed to the downside. The risk is skewed to the upside here. It looks like the older deals...when you had a lot of downside protection,” he said.

“I think the risk/reward is very good.”

Fixed income bucket

Matt Medeiros, president and chief executive of the Institute for Wealth Management, also saw the notes as a potential item in his fixed income portfolio.

“It’s an interesting long-term hold,” he said.

“I like the index. I also like the fact that the barrier is very unlikely to be breached.”

“It’s nice to have this kind of minimum return. It’s not a huge coupon but it’s guaranteed on the upside.”

One important consideration was to decide how to allocate the notes.

“Do you use it in your equity bucket or in your fixed-income bucket?”

“You may consider the equity allocation if you have low return expectations, but it’s hard to have a view over such a long period of time.

“I’d be much more inclined to use it as fixed-income replacement,” he said.

The absence of income payments did not make a difference, he said.

“When people buy fixed-income products or bond-like assets, they’re not always looking for income. They’re looking for a low-risk investment paying a nice coupon with potential upside,” he said.

“This note does just that.”

Medeiros brought up another reason behind his allocation decision.

“It’s a bond alternative in that you’re taking less risk compared to a regular bond. Rates can go up, this note tied to an equity index will shelter you from interest rate risk,” he said.

Not income

Steve Doucette, financial adviser at Proctor Financial, was more skeptical about the product.

“You’re really bearish in this note. It’s like being long the index with a safety net that gives you less than 5% a year.

“And you’re definitely a bear if you need a 55% barrier seven years from now,” he said.

Doucette did not subscribe to the notion that the notes could be used as a bond substitute.

“How can I see it as income replacement when I’m not getting any income for seven years?” he said.

The lack of income payments was reflected in the more favorable tax treatment.

“Perhaps one advantage of this versus an income product is the tax treatment. You’re not getting taxable income. You’re taxed on long-term capital gains at maturity if you hold it,” he said.

“But if you really want income, look for an autocall. I can’t imagine you wouldn’t be able to stretch out a higher coupon over seven years. Keeping the same 55% barrier, you might be able to get a 6% or 7% coupon or even more. You may have to give up the upside at maturity but if what you’re looking for is income, typically you don’t go for the index return, so it doesn’t matter.”

Other choices

Doucette said that very few clients would be willing to invest in a note over such a long period of time.

“Your money is tied up for seven years. How do you get out of it if you want to sell in two or three years?” he said.

Alternative structures would be more efficient to provide either income or upside participation, he added.

“Again, I would look at a much shorter-dated autocall with a higher coupon.

“Alternatively, I would put a 5% buffer and see what kind of leverage I could get.”

“As we are in this market, do I expect another downside cycle seven years from now? No. I would expect the market to be up.

“That’s what makes this 55% barrier a little bit odd, at least on a seven-year paper,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Wednesday.

The Cusip number is 61774DBS5.

The fee is 3.35%.

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