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March 30, 2021

2021 Investment Outlook: Managing Portfolio Risk During a Period of Equity Highs and Interest Rate Lows

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March 30, 2021

2021 Investment Outlook: Managing Portfolio Risk During a Period of Equity Highs and Interest Rate Lows


Insight Article

2021 Investment Outlook: Managing Portfolio Risk During a Period of Equity Highs and Interest Rate Lows

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March 30, 2021

 
 

As we begin 2021, stocks remain at record highs while interest rates are at all-time lows—clearly this current market environment does not set up well for the traditional 60/40 portfolio. Investors who relied on the long-held assumption of consistently negative correlations between stocks and bonds may, in our view, find it challenging to produce similar results for their portfolios vs. previous years to the extent that markets begin to normalize.

Against this backdrop, we believe that investors interested in new ways to not just create, but also to protect their wealth, may want to consider risk management tools which do not rely solely on the equity vs. rates diversification assumption. Rotation from Delta-1 equity strategies into select structured investment strategies may provide a downside buffer, to the extent markets selloff, and also leverage on the upside, to the extent markets trade sideways.

 
ron.bezoza
Head of the Managed Solutions Group
 
nathan.sheldon
Executive Director
Managed Solutions Group
 
william.littleton
Vice President
Managed Solutions Group
 
 
 
The Managed Solutions Group specializes in outcome-oriented investment strategies that provide tailored exposure to equity markets through separately managed accounts.
 
 
 

INFORMATION:

An investment in the leveraged upside securities involves significant risks. Investors should consult their investment, legal, tax, accounting and other advisors before they invest in the leveraged upside securities. Investing in the leveraged upside securities is not equivalent to investing directly in the underlier or any of the securities composing the underlier. Some of the risks that apply to an investment in the leveraged upside securities are summarized below, but we urge you to read the more detailed explanation of risks relating to the leveraged upside securities generally in the “Risk Factors” section of a leveraged upside securities prospectus supplement. You should not purchase the leveraged upside securities unless you understand and can bear the risks of investing in the leveraged upside securities.

The leveraged upside securities do not pay interest and provide a minimum payment at maturity of only 10% of your principal. The terms of the leveraged upside securities differ from those of ordinary debt securities in that the leveraged upside securities do not pay interest and provide a minimum payment at maturity of only 10% of your principal. If the final underlier value is less than the initial underlier value by more than the buffer amount of 10%, the payment at maturity will be an amount in cash that is less than the $10 stated principal amount of each leveraged upside securities by a percentage equal to the percentage decrease from the initial underlier value to the final underlier value beyond the buffer amount. You may lose up to 90% of your initial investment in the leveraged upside securities.

The appreciation potential of the leveraged upside securities is limited by the maximum payment at maturity. The appreciation potential of the leveraged upside securities is limited by the maximum payment at maturity based on respective cap per each leveraged upside securities. The actual maximum payment at maturity will be determined on the pricing date. Although the leverage factor provides 200% exposure to any increase in the final underlier value as compared to the initial underlier value, because the payment at maturity will be limited to at least a max return of the stated principal amount for the leveraged upside securities, any increase in the final underlier value as compared to the initial underlier value by more than the cap (in the case where the maximum payment at maturity is a capped percentage of the stated principal amount) of the initial underlier value will not further increase the return on the leveraged upside securities.

Credit of issuer. The leveraged upside securities are unsecured and unsubordinated debt obligations of the issuer, and are not, either directly or indirectly, an obligation of any third party. Any payment to be made on the leveraged upside securities, including any repayment of principal, is subject to the ability of each issuer to satisfy its obligations as they come due and is not guaranteed by any third party. As a result, the actual and perceived creditworthiness of the issuer may affect the market value of the leveraged upside securities and, in the event the issuer were to default on its obligations, you might not receive any amount owed to you under the terms of the leveraged upside securities.

Investing in the leveraged upside securities is not equivalent to investing in the underlier or the securities composing the underlier. Investors in the leveraged upside securities will not have voting rights or rights to receive dividends or other distributions or any other rights with respect to the securities composing the underlier.

The leveraged upside securities will not be listed on any securities exchange, and secondary trading may be limited. The issuers intend to offer to purchase the leveraged upside securities in the secondary market but are not required to do so and may cease any such market making activities at any time, without notice. Even if a secondary market develops, it may not provide enough liquidity to allow you to trade or sell the leveraged upside securities easily. Because other dealers are not likely to make a secondary market for the leveraged upside securities, the price, if any, at which you may be able to trade your leveraged upside securities is likely to depend on the price, if any, at which the issuers are willing to buy the leveraged upside securities. In addition, the issuer may at any time hold an unsold portion of the leveraged upside securities (as described on the cover page of this document), which may inhibit the development of a secondary market for the leveraged upside securities. The leveraged upside securities are not designed to be short-term trading instruments. Accordingly, you should be willing and able to hold your leveraged upside securities to maturity.

The final underlier value is not based on the value of the underlier at any time other than the valuation date. The final underlier value will be based solely on the closing level of the underlier on the valuation date and the payment at maturity will be based solely on the final underlier value as compared to the initial underlier value. Therefore, if the value of the underlier has declined as of the valuation date, the payment at maturity, if any, may be significantly less than it would otherwise have been had the final underlier value been determined at a time prior to such decline or after the value of the underlier has recovered. Although the value of the underlier on the maturity date or at other times during the term of your leveraged upside securities may be higher than the closing level of the underlier on the valuation date, you will not benefit from the value of the underlier at any time other than on the valuation date.

Adjustments to the underlier could adversely affect the value of the leveraged upside securities. The sponsor of the underlier may add, delete, substitute or adjust the securities composing the underlier or make other methodological changes to the underlier that could affect its performance. The calculation agent will calculate the value to be used as the closing level of the underlier in the event of certain material changes in or modifications to the underlier. In addition, the sponsor of the underlier may also discontinue or suspend calculation or publication of the underlier at any time. Under these circumstances, the calculation agent may select a successor index that the calculation agent determines to be comparable to the underlier or, if no successor index is available, the calculation agent will determine the value to be used as the closing level of the underlier. Any of these actions could adversely affect the value of the underlier and, consequently, the value of the leveraged upside securities.

Hedging and trading activity by the issuer and its affiliates could potentially adversely affect the value of the leveraged upside securities. The hedging or trading activities of the issuer’s affiliates and of any other hedging counterparty with respect to the leveraged upside securities on or prior to the pricing date and prior to maturity could adversely affect the value of the underlier and, as a result, could decrease the amount an investor may receive on the leveraged upside securities at maturity. Any of these hedging or trading activities on or prior to the pricing date could potentially increase the initial underlier value and, therefore, the value at or above which the underlier must close on the valuation date so that the investor does not suffer a loss on their initial investment in the leveraged upside securities. Additionally, such hedging or trading activities during the term of the leveraged upside securities, including on the valuation date, could potentially affect the value of the underlier on the valuation date and, accordingly, the amount of cash an investor will receive at maturity, if any.

The market price of the leveraged upside securities will be influenced by many unpredictable factors. Several factors will influence the value of the leveraged upside securities in the secondary market and the price at which the issuer may be willing to purchase or sell the leveraged upside securities in the secondary market. Although we expect that generally the value of the underlier on any day will affect the value of the leveraged upside securities more than any other single factor, other factors that may influence the value of the leveraged upside securities include:

  •  the volatility (frequency and magnitude of changes in value) of the underlier;
  • dividend rates on the securities composing the underlier;
  •  interest and yield rates in the market;
  • time remaining until the leveraged upside securities mature;
  • supply and demand for the leveraged upside securities;
  • geopolitical conditions and economic, financial, political, regulatory and judicial events that affect the securities composing the underlier and that may affect the final underlier value; and
  • any actual or anticipated changes in our credit ratings or credit spreads.

The value of the underlier may be, and has recently been, volatile, and we can give you no assurance that the volatility will lessen. You may receive less, and possibly significantly less, than the stated principal amount per leveraged upside securities if you try to sell your leveraged upside securities prior to maturity.

The estimated value of your leveraged upside securities is expected to be lower than the initial issue price of your leveraged upside securities. The estimated value of your leveraged upside securities on the pricing date is expected to be lower, and may be significantly lower, than the initial issue price of your leveraged upside securities. The difference between the initial issue price of your leveraged upside securities and the estimated value of the leveraged upside securities is expected as a result of certain factors, including the estimated cost that the issuer may incur in hedging its obligations under the leveraged upside securities, and estimated development and other costs that may be incurred in connection with the leveraged upside securities.

The estimated value of your leveraged upside securities might be lower if such estimated value were based on the levels at which our debt securities trade in the secondary market. The estimated value of your leveraged upside securities on the pricing date is based on a number of variables, including internal funding rates. Internal funding rates may vary from the levels at which benchmark debt securities trade in the secondary market. As a result of this difference, the estimated values referenced above might be lower if such estimated values were based on the levels at which benchmark debt securities trade in the secondary market.

The estimated value of the leveraged upside securities is based on internal pricing models, which may prove to be inaccurate and may be different from the pricing models of other financial institutions. As a result, the secondary market price of your leveraged upside securities may be materially different from the estimated value of the leveraged upside securities determined by reference to internal pricing models.

The estimated value of your leveraged upside securities is not a prediction of the prices at which you may sell your leveraged upside securities in the secondary market, if any, and such secondary market prices, if any, will likely be lower than the initial issue price of your leveraged upside securities and may be lower than the estimated value of your leveraged upside securities. The price at which you may be able to sell your leveraged upside securities in the secondary market at any time will be influenced by many factors that cannot be predicted, such as market conditions, and any bid and ask spread for similar sized trades, and may be substantially less than our estimated value of the leveraged upside securities. As a result, the price at which the issuer may be willing to purchase the leveraged upside securities from you in secondary market transactions, if any, will likely be lower than the price you paid for your leveraged upside securities, and any sale prior to the maturity date could result in a substantial loss to you.

The temporary price at which we may initially buy the leveraged upside securities in the secondary market and the value we may initially use for customer account statements, if we provide any customer account statements at all, may not be indicative of future prices of your leveraged upside securities.

The U.S. federal income tax consequences of an investment in the leveraged upside securities are uncertain. There is no direct legal authority regarding the proper U.S. federal income tax treatment of the leveraged upside securities, and we do not plan to request a ruling from the Internal Revenue Service (the “IRS”). Consequently, significant aspects of the tax treatment of the leveraged upside securities are uncertain, and the IRS or a court might not agree with the treatment of the leveraged upside securities as described by the issuer in the relevant offering documents. If the IRS were successful in asserting an alternative treatment for the leveraged upside securities, the tax consequences of the ownership and disposition of the leveraged upside securities could be materially and adversely affected. In addition, in 2007 the Treasury Department and the IRS released a notice requesting comments on various issues regarding the U.S. federal income tax treatment of “prepaid forward contracts” and similar instruments. Any Treasury regulations or other guidance promulgated after consideration of these issues could materially and adversely affect the tax consequences of an investment in the leveraged upside securities, possibly with retroactive effect.

The document is a general communications which is not impartial and has been prepared solely for information and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

The information and analyses contained herein are not intended as investment, tax or legal advice. The data and information provided are based primarily upon information provided to Morgan Stanley by unaffiliated third parties. This data and information is believed to be reliable. Morgan Stanley does not undertake to update this, and the results discussed may change without notice. Morgan Stanley shall not in any way be liable for claims relating to these materials and makes no express or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in, or omissions from, them.

The views and opinions expressed are those of the investment team at the time of writing/of this presentation and are subject to change at any time due to market, economic, or other conditions, and may not necessarily come to pass. These comments are not representative of the opinions and views of the firm as a whole.

This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

Morgan Stanley is a full-service securities firm engaged in a wide range of financial services including, for example, securities trading and brokerage activities, investment banking, research and analysis, financing and financial advisory services.

A separately managed account may not be suitable for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

 

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