Morgan Stanley’s trigger PLUS on Energy ETF offer value, but sector, barrier are concerns

By Emma Trincal

New York, April 2 – Morgan Stanley Finance LLC’s 0% trigger Performance Leveraged Upside Securities due April 4, 2024 tied to the Energy Select Sector SPDR fund exemplify a “buy-at-the-dip” strategy, which advisers found attractive. But their respective concerns gravitated around the future of the oil industry as well as the downside protection offered by the issuer.

If the ETF finishes above its initial level, the payout at maturity will be par of $10 plus 250% of the ETF return, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF finishes at or below its initial level but at or above its trigger level, the payout will be par. The trigger level is 85% of the initial index level.

If the ETF finishes below its trigger level, investors will be fully exposed to the ETF’s decline from its initial level.

Tumult in oil

“The sector has been hammered. If you’re confident that the energy infrastructure will not collapse in four years, that may not be a bad deal especially with this type of leverage and no cap,” said Steve Doucette, financial adviser at Proctor Financial.

Oil has been in a severe bear market, especially last month as a result of a price war between Saudi Arabia and Russia. The coronavirus pandemic of course has created further damage by reducing travel worldwide.

West Texas Intermediate crude oil has dropped 59% year to date.

Rally

The Energy Select Sector SPDR fund, which comprises stocks of the large U.S. oil companies, is down by more than half of its value from the beginning of the year. The price bottomed two weeks ago and has since gone up by 30%.

Oil rallied on Thursday on the news that Saudi Arabia and Russia may cut production.

The share price of Exxon Mobil Corp. and Chevron Corp., which make nearly 50% of the fund combined, were up 7.65% and 11%, respectively, on Thursday. The ETF itself rose by more than 9%.

“I’m pretty confident that when the virus, the Russia/ Saudi oil war will be behind us four years from now, the sector will recover. Until we go green, oil companies will be around for a while,” he said.

“You get 2.5 times and if you’re wrong you have a 15% barrier. It’s not a bad note.”

New competitors

Yet, Doucette said he would need to do further research on the sector. With the development of new energies offering alternative to fossil fuels, he has grown more skeptical about the competitive edge of oil stocks over the long run.

“We don’t do a lot of sector bets and with energy you really have to do your due diligence,” he said.

“I do believe those big companies will be around, but you can’t underestimate renewable energy, in particular solar energy.

Solar

“Maybe some of those major oil companies will adjust and begin manufacturing solar panels and other alternatives, diversifying away from oil. I’m skeptical. I think they will continue to focus on oil. They’ll have to face competition from new sources of energy, which will become more and more attractive because you can save a bundle on your electric bills when you install a solar panel.”

Doucette said he has himself installed one in his house to cut costs.

“I’ll have a zero-electric bill and it pays for itself back in six years,” he said.

As an investor, he likes Enphase Energy, Inc., a solar panel supplier.

Overall, his main concern with the underlying was its concentration on oil stocks.

The industry breakdown within the fund is two-fold: oil, gas and consumable fuels, which make for 91.55% of the portfolio, and energy equipment and services for the rest, according to State Street Global Advisors Funds Distributors, LLC, the ETF distributor. All companies are involved in the oil and gas industry.

“It’s an energy ETF but it’s the big oil companies only. If they had more stocks like Enphase, I would be more excited about that,” he said.

Risk is high

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, said he believed in the recovery of the oil equity market. His concern was not about the health of the sector itself but rather about the downside structure of the product. The extreme volatility associated with the current pandemic made all predictions challenging, he said. Despite the low entry point, he was not comfortable enough with the structure to consider investing in the notes.

“Obviously in this deeply distressed sector, this is an interesting note,” he said.

“However, because it has a barrier, I probably wouldn’t be looking into doing it.

“The sector remains extremely volatile. In the short term, there is a possibility for a retracement.

“Even if I believe the sector will recover quite nicely in four years, you still have to manage your risk, and with such a volatile asset class, you need a more substantial protection.”

Leverage, barrier

On the upside the leverage was advantageous to investors not only to boost returns but also to help them better compete with the underlying fund over a four-year period.

“You’re not getting the dividends, and this ETF happens to offer a very high yield. That’s something investors need to take into consideration,” he said.

The fund has an 8.3% dividend yield. With an annual return of less than 6%, investors in the notes will underperform the fund. But with a more aggressive performance, the leverage will compensate them, making the notes more attractive.

“Because the leverage is high, it gives you a chance to offset the lack of dividends, which is a good thing.”

But Medeiros, looking at the downside risk, said he still did not feel confident with the barrier.

“If it had a buffer it would be a no-brainer. It would be an attractive note,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will settle on Friday.

The Cusip number is 61770FYC4.

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