Morgan Stanley’s $6 million trigger PLUS on Topix offer long-term bull play on Japan

By Emma Trincal

New York, May 5 – Morgan Stanley Finance LLC’s $6 million of 0% trigger PLUS due May 2, 2029 linked to the Topix index offer investors a chance to strongly outperform the index on the upside. But combining the bullish bet on equities with one on the Japanese yen would have made the notes much more attractive, a contrarian investor said.

If the index return is positive, the payout at maturity will be par plus 275% of the index return. Investors will receive par if the index return is negative but ends at or above the 65% trigger and will lose 1% for every 1% decline if it ends below the trigger level, according to a 424B2 filing with the Securities and Exchange Commission.

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, pointed to two advantageous features.

“Six years is probably a positive,” he said.

“We’re near the top of the cycle. If we have a downturn, six years gives you enough time to recover from it. You could have a downturn lasting two or two-and-a-half years. But there is no chance it would last six years.”

The underlying was a good pick.

“The Japanese market is not nearly as overvalued as the U.S. market. It’s closer to fair value. So that’s another positive,” he said.

Opportunity cost

But with a longer maturity came the greater opportunity cost associated with unpaid dividends.

“I think that’s the only real negative. The main problem with this note is that you would give up a fair amount of dividends, especially over six years,” he said.

The dividend yield of the Topix index is approximately 2.6%. On a compounded basis, noteholders give up about 17.5% in dividends over the term.

“On the other hand, there is plenty of leverage to offset the lack of dividends. And that’s a good thing,” he said.

Breaking even

On the upside, the breakeven point at which noteholders would begin to outperform the underlying would be +10%.

“You’re better off with the notes if the index is up at least 10%. That’s when the leverage offsets the loss of dividends,” he said.

“On the downside, the notes would outperform if the index dropped more than 17.5% but less than 35%.”

The decline of more than 17.5% is required to offset the 17.5% amount of unpaid dividends. But a drop beyond the 65% barrier would nullify the protection and cause the notes to trail the index.

Bull play

Kaplan looked at the zone in which shareholders would get a better return than noteholders.

“If the index falls between -17.5% and +10%, you’re better off with the Topix,” he said.

“If you want to outperform the index, you have to have a relatively large loss but one that doesn’t breach the barrier level,” he said.

“Alternatively, you need a gain of 10% or more. It doesn’t seem like a lot over six years but that’s just the breakeven. What you really want is a big gain. You have a lot of leverage and there is no cap. You want to be as bullish as possible to optimize this payout and maximize your return.

“This note is for a long-term investor looking for a big gain in Japan.”

No yen, no game

Kaplan said one of the missing features was the absence of currency exposure.

“I’m more bullish on the Japanese yen than I am on Japanese equities,” he said.

“The Japanese yen right now is amazingly cheap. It is very inexpensive to live in Japan, much more inexpensive than living in an ordinary city in the U.S. In fact, more and more Americans are retiring in Tokyo.”

For Kaplan the depreciated Japanese yen was an anomaly.

“Why is the Japanese yen so low versus the U.S. dollar? I don’t think anybody has a clue. But I also don’t think this situation will persist over a long period of time,” he said.

The notes are currency neutral as most notes linked to an international equity index are.

Issuers use so-called quanto options to achieve this result.

If the Japanese yen was to strengthen against the U.S. dollar, noteholders would have no way to benefit from the appreciation. On the other hand, investors are hedged against a weakening of the Japanese yen.

“I am quite bullish on the Japanese yen,” he said.

“I would rather invest in a Japanese ETF like [the iShares MSCI Japan ETF.] You’re likely to gain a lot more from the appreciation of the Japanese yen against the dollar than from the Japanese stock market.

“Not being able to take advantage of that is a bit disappointing.

“You’re losing a great opportunity to enhance your equity return.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on Wednesday.

The Cusip number is 61774XRH8.

The fee is 3.5%.

© 2015 Prospect News.
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