Advisers assess Morgan Stanley’s principal-protected notes on Dow based on economic views

By Emma Trincal

New York, July 26 – Morgan Stanley Finance LLC’s 0% market-linked notes due July 30, 2027 linked to the Dow Jones industrial average provide a defensive strategy over a relatively long period of time, advisers said.

While the structure offers benefits, their decision to invest in the product would be largely influenced by their economic expectations, they said.

If the final index level is greater than the initial level, the payout at maturity will be par plus the gain, subject to a maximum return of 52% to 58%, according to an FWP filing with the Securities and Exchange Commission. The exact maximum return is set at pricing.

If the index declines, the payout will be par.

Inflation

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group liked the structure but not the current economic environment.

“That to me is interesting. Personally, it doesn’t align with my thesis about the economy. But the note is well designed. If you think the market will be higher in five years, it’s an excellent note,” he said.

Chisholm said he is not optimistic in large part due to inflation.

“As I see it, the next few years are going to be rocky with high probabilities of greater downside. If you can lock in 0% loss with a potential of 52% gains, to me that’s a win. It’s a very good structure,” he said.

“But from an economic standpoint, we’re in a situation reminiscent of the 1970s, a period plagued with high volatility and inflation. As long as we have high inflation and high interest rates, we’re going to have lower asset prices.”

Risk return

Chisholm said he could not predict the future especially not over five years.

“You can’t really tell. We don’t know what politicians might be doing. They could decide to reverse course and shift to lower rates even though inflation is at 10%.

“So, taking the risk of a long-term market exposure in this environment is not something I would want to do even though the principal-protection is extremely attractive,” he said.

For Chisholm, investors may be locked in for a long time without significant gains.

“I think it’s extremely unlikely that the index would rise anywhere near the cap.

“But I do like the risk/reward of the note,” he said.

A long time

Jonathan Tiemann, president of Tiemann Investment Advisor, had a more optimistic market outlook.

He attributed the possibility to price 100% protection to the moves in interest rates. Since the beginning of the year, the five-year Treasury yield has increased by more than 150 basis points.

“It looks like the principal-protection is provided by a zero-coupon. Separately you get the upside with calls. This type of deal is only possible because interest rates are a little bit higher,” he said.

Higher rates make for wider discounts on the zero, which frees up capital for the purchase of the options.

“You give up the dividend and the liquidity for the principal protection. That’s the tradeoff,” he said.

One caveat for this adviser: the term.

“I don’t love structured notes with very long tenors. Five years is a long time,” he said.

“The odds that the Dow would be lower in five years are relatively small.

“Getting a negative return over such a period of time is quite rare statistically.

“I’m not sure I would want to purchase that amount of protection on a five-year note.”

Expectation game

Getting the same amount of downside protection over a short period of time would be challenging in terms of pricing but worthwhile for investors, he said.

“Oddly, protection is more valuable if the tenor is shorter. I would push in that direction. But how far can you push for a shorter term and still get the full downside protection? Probably not very far. As a compromise I may settle for a buffer,” he said.

The cap, even at the lower end of the range, was satisfactory.

“It’s fine. It’s right around the average of 10% per year,” he said.

But it was “impossible to predict” whether the cap could be reached in five years.

The economy more than the market may be the wildcard, according to this adviser.

“For the immediate term, I think we may get some relief here. The chatter is about whether we’re going to have a recession,” he said.

But a recession is “not the worst thing” for the market, he said.

“The market is always anticipatory. The recession is already priced in. The market has been anticipating a recession for some time and I wouldn’t be surprised if the market was to go up as we get into the highly anticipated recession.”

Fed action

On a positive note, Tiemann said the Fed’s tightening efforts may be coming to fruition.

“The Fed may be closer to being done than we have thought back a few months ago.

“I’m more pessimistic about the economy than about the market. Whatever bad news the market may be anticipating may come to pass.

“But I don’t have a view over five years. It’s basically impossible to predict. This is the main issue with the note,” he said.

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent. UBS Financial Services Inc. is acting as dealer.

The notes were expected to price on July 26 and to settle on July 29.

The Cusip number is 61774DF85.

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