Morgan Stanley’s trigger jump notes on Brent show attractive structure, portfolio manager says

By Emma Trincal

New York, March 3 – Morgan Stanley Finance LLC’s $350,000 of 0% enhanced trigger jump securities due March 27, 2024 linked to Brent crude oil futures contracts offer a “decent” structure to navigate the volatile oil market, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the commodity gains or ends above the 60% downside threshold, the payout at maturity will be par plus 13.5%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% that the commodity declines if it finishes below the downside threshold level.

Three good things

Kaplan highlighted some of the positive aspects of the structure, starting with the barrier.

“The most recent high for Brent was in March 2022 at 134.91, but it was not that low at all if you compare it with levels seen in the spring of 2020 during the pandemic,” he said.

The notes priced late last month when Brent crude oil was at $83.16, setting the barrier level at approximately $50.

“Brent has been consistently trading below 50 from February to December of 2020 falling below 20 in April of that year,” he said.

The barrier would be breached if the price reverted to these levels. But at least 40% provided a “very generous” protection, he said.

Another advantageous element was the choice of the underlying.

“They picked Brent futures, which are not as volatile as WTI futures. Brent is much more stable,” he said.

West Texas Intermediate (WTI) is the main oil benchmark for North America. Brent is the benchmark for Europe, Africa and the Middle East.

Kaplan also liked the payout.

“At least it's reasonable given the uncertainty associated with oil,” he said.

“I wouldn't say 13.5% is necessarily generous. But you can get it if the price plunges. I like the idea of taking a very volatile security and coming up with a note that's predictable. They monetize the volatility to give you a defined payout. That’s an easy-to-understand concept. You either get it or you don't.”

High volatility

Brent when the notes priced traded 38.5% off its March 2022 high.

“Just because it's down doesn't mean it cannot drop further,” he said.

“Some people place bullish bets based on how much an asset price has already dropped. Somehow, they assume that a big drop means the price has bottomed. These people usually go broke because they don’t take into account the volatility of the market, especially for an asset like oil. They’re overconfident, but you can't be overconfident with oil. Oil has been the most volatile market in the last three years or even going back to 2008 when you had huge fluctuations.”

To be sure, Brent crude oil fell by more than 75% from a peak of $147.50 in July 2008 to a low of $36.20 five months later.

“The talking heads at the time said there was a shortage of oil in the summer and a surplus in December. Meanwhile supply and demand did not change during that time,” he said.

“Commodity prices vary dramatically without any change in the fundamentals of supply and demand.”

Storytelling

Investing in commodities and oil in particular is a complex endeavor made even more challenging by the flurry of “simplistic” headlines that tend of influence and often mislead investors, he said.

“The media come up with all kinds of theories and explanations that prove wrong all the time. One of them was that inflation spikes lead to higher oil prices. Usually, it’s the other way around. Oil shocks in the past were followed by periods of elevated inflation,” he noted.

“Here’s another one: when Russia invaded Ukraine, the consensus was that oil prices would surge. Indeed, prices climbed in March and in June. But the trend was short-lived. Starting in June oil has been trending down consistently.

Kaplan pointed to the inverse relationship between the U.S. dollar and oil as a sign that oil prices may be headed lower.

“Investors have been looking for a safer place to put their money and the U.S. dollar has appreciated as a result,” he said.

“If people expect more global economic uncertainty as they have done during the past two years, then this will cause the U.S. dollar to be higher as a safe haven, and for commodities including Brent crude to be lower.”

“It is the perception of the future which causes assets to fluctuate.

“This is why you need a barrier, and the issuer here gives you generous one,” he said.

Good timing

Another benefit of the note was its duration.

“It’s a 13-month, which is a short timeframe. That’s an advantage because by March of 2024, I don’t expect oil prices to go back to their 2020 levels, which is the barrier level,” he said.

“Based on historical analysis of previous bear markets, I expect 2024 to be a bad year but not before the summer. I think by March 2024, you will still be able to avoid the worst. If this note had been a two-year, I would be very nervous. But given previous cycles, I think oil prices will bottom around March 2025, not next year.”

Overall, Kaplan said the notes offered a number of positive features.

“It’s a very favorable structure to have. You’ll get paid unless oil prices collapse. Your barrier is very protective, and they picked the right oil benchmark,” he said.

“In addition, by the time the notes mature, you won’t be crushed by the most brutal phase of the bear market just yet. That one always come at the end when people panic sell.”

“So overall, it’s a pretty good structure.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent with JPMorgan Chase Bank, NA as placement agents.

The notes settled on Wednesday.

The Cusip number is 61774FBJ0.

The fee is 1%.

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