Morgan Stanley’s $14.59 million barrier notes on SPDR Gold offer alternative cap

By Emma Trincal

New York, Nov. 8 – Morgan Stanley Finance LLC’s $14.59 million of barrier market-linked notes due Oct. 30, 2025 linked to the SPDR Gold Trust offer an innovative way to structure a cap using a daily observation barrier. The main advantage is the full downside protection and the guarantee of a return in the event of a knock-out.

At maturity, investors will receive par plus 19% if the ETF closes above 140% of its initial level at any point during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If this has not happened, investors will receive par plus the return of the ETF if the final level is greater than the initial level.

Otherwise, investors will receive par.

Shark note

“It’s definitely unique. It’s a shark type except that the 19% rebate is much bigger than normal. Typically, it’s about 5%,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

“The upper barrier of 40% is a high threshold. For gold to be up 40% in two years is very unlikely. I like it.”

A shark note is a fully principal-protected product, whose payout is linked to the underlying up to a cap as long as a continuously observed barrier is never breached. The cap is set at the barrier level. If the barrier is breached, investors lose the right to participate in the return and receive instead a fixed payout often called “rebate,” which is lower than the cap. In this case, the cap is 40% and the rebate, 19%.

Safer exposure

“You’re fully protected. You get one-to-one with gold. That’s the most probable scenario on the upside because the 40% barrier is so high, you’re less likely to reach it,” said Beals.

“But even if you go above the barrier, you’re still getting 19%, which is a very decent return.

“I see it as a way to get 100% participation in gold, capped at 40% in two years with no downside risk.

“If you want exposure to gold, it’s a safe way to achieve it.”

Gold is considered as an inflation hedge and may attract investors concerned about persisting inflation, he said.

“Gold is the classic safe haven. There may be many reasons to seek exposure to this alternative investment. Usually, it’s if you believe that inflation will be higher. Geopolitically, if the conflict in the Middle East spreads you may expect gold prices to move higher as well.

“From that defensive perspective, the note gives you a pretty good access to the asset class,” he said.

New cap

A buysider said the note was “innovative,” but not easy to sell to a client.

“I guess you want the principal protection first of all,” he said.

“It’s an interesting way to cap a note. It’s either a digital return at 19% or 100% of the gain capped at 40% if you breach the daily-observation barrier.

“The 19% digital is not bad.”

But the digital payout would also significantly limit the upside if the ETF finished well above it, he noted.

Uncertainty

Any gain above the 40% threshold could be viewed as an opportunity cost by investors as the 19% rebate is half the size of the 40% cap in a participation scenario.

“It can be a little bit concerning if gold is up 35% in 18 months. You would be hoping not to breach the 40% barrier.

“The note would undoubtedly outperform the ETF if the price finished below 19% all the way down to zero.

“It seems to be a narrow window to feel good about the trade,” he said.

The unknown payout may not bode well with some investors. Cash would offer the same downside protection against market risk while removing the uncertainty.

“If you get the 19% digital, it is roughly a 10% per year return. For 5% less, you can sit in a 5% money market at no risk,” he said.

“It’s an innovative play on a cap. But I’m having a hard time finding the rationale behind this investment.”

The daily monitoring of the barrier and its potential breach may cause noteholders to experience “FOMO” or “fear of missing out,” he added.

FOMO

“At first glance the trade looks good. You have full principal protection. You get one-to-one up to 40% in two years. You could have 19%, and that’s not bad.

“But is it really worth the feeling of a potential failed trade? What if it’s up 60% and you only get 19%?

“There is definitely a FOMO aspect to this trade,” he said.

Morgan Stanley guarantees the notes.

UBS Financial Services Inc. and Morgan Stanley & Co. LLC are the agents.

The notes settled on Oct. 31.

The Cusip number is 61775MMT0.

The fee is 2%.

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