Goldman Sachs’ 17- to 20-week notes linked to Topix seen as pure and short access play

By Emma Trincal

New York, Jan. 5 – GS Finance Corp.’s upcoming 0% Topix index-linked notes are intriguing, advisers said, due to the extreme brevity of the product’s life, the one-to-one exposure to the index and the issuer itself. GS Finance is a subsidiary of Goldman Sachs Group, Inc.

The notes are expected to mature 17 to 20 weeks after pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus any index gain. Investors will be exposed to any index decline.

Five months maximum

Tom Balcom, founder of 1650 Wealth Management, noticed first the short duration.

“This has got to be something created for one client, something they designed just for that type of view,” he said.

“It’s almost a trade. Four to five months. It’s probably an institution.

“The investor has to be someone with a very short-term view on the Japanese equity market. It has no buffer, no leverage. You have to be quite bullish. Without the downside protection, you have to be pretty confident that you’re right.

“It’s got to be for someone who knows something or anticipates something. I don’t know what exactly ... perhaps a positive view on the impact of Abenomics or they may anticipate more easing ahead.”

The term Abenomics refers to the stimulus policy introduced by Prime Minister Shinzo Abe.

Balcom said that participation notes are rarely as short as this one.

“Usually when you see a three- or six-month deal, it’s a reverse convertible,” he said.

Not so retail

Donald McCoy, financial adviser at Planners Financial Services, said the very short tenor would be a problem for him.

“My big question is, why would a retail investor be interested in such a short duration? What’s the point of investing for less than half a year? Some people I guess may be happy to buy and sell stuff on a regular basis, but these wouldn’t be the type of clients I do business with. This type of maturity would not be suitable for my clients.

“I think for a retail investor to just buy something for 17 or 20 weeks is just a flip of a coin over a short timeframe.

“You get no benefits other than the exposure to that index. You’re not getting downside protection, no bonus, no leverage.

“Why wouldn’t I go out and get something similar even if it’s not exactly the same index?”

Index-linked

The fact that the product is a tracker is also an intriguing aspect of the notes, according to the advisers.

“You obviously buy this note for access. You do it to get exposure to the Topix,” said Balcom.

“You’re not getting any option-like results. No leverage, no protection. It’s pure replication.”

Asked whether access is a valid reason to buy a structured note if there is nothing else in the structure to justify the investment, his answer was negative.

“We wouldn’t just do a pure access play, which is what this note is about. We wouldn’t do it even if there wasn’t any other way to get the exposure,” he said.

“We want to have some kind of protection aspect to it. With a structured note, you add credit risk to the equation. We want to be compensated for that either with leverage or downside protection. If you get neither, we lose the appetite for it.”

Access

McCoy agreed: the main motivation to buy the notes is access.

“They’re creating an investment to get exposure to an index that’s not easily available,” he said.

“I don’t know if there is no easy access to the Topix, but even if it’s the case, you can get similar exposure to similar Japanese benchmarks. There are tons of Japanese ETFs out there.”

The Topix, or Tokyo Price index, is a capitalization-weighted index of all the domestic common stocks listed on the First Section of the Tokyo Stock Exchange, according to the prospectus. Stocks listed in the First Section, which number roughly 1,700, are among the most actively traded stocks on the Tokyo Stock Exchange.

The Topix is viewed as one of the most representative benchmarks of the Japanese equity market given its broad inclusion of all the largest companies on the exchange.

According to a 2014 research note penned by two Deutsche Bank strategists, Shan Lan and Will Stephens, the Topix is a “very difficult index to replicate.” The problem is due to the benchmark’s “high number of constituents and the fact that the ‘tail’ consists of a large number of relatively illiquid small caps,” they wrote in a piece titled “Land of the Rising Allocation.”

In the United States, there is an ETF that tracks the S&P/Tokyo Stock Price Index (TOPIX) 150 index. The fund is listed on the NYSE Arca under the symbol “ITF.”

But the replicated index, which is limited to 150 stocks, is distinct from the Topix.

Other well-known ETFs track some Japanese indexes, but they are not linked to the Topix. Some examples include the iShares MSCI Japan ETF or the Japan Hedged Equity Fund.

GS Finance

Finally the use of a Goldman Sachs’ affiliate to issue the notes is another interesting aspect of the deal, advisers said.

GS Finance gained visibility last year when it brought to market larger-than-average deals.

It priced five offerings ranging from $100.5 million to $350 million, according to data compiled by Prospect News.

One for $100.45 million was a Topix-based offering. Three, including the largest one for $350 million, were linked to the S&P 500 index. The other was a rate offering.

Some sources attribute the use of GS Finance by Goldman Sachs as a way for the bank to comply with more stringent capital requirements the regulators have recently imposed on bank holding companies.

“The fact that it’s not issued by Goldman Sachs itself, the parent company, wouldn’t bother me,” said Balcom.

“It wouldn’t impact my decision in terms of credit rating. If they’re a subsidiary and if the holding company guarantees the notes, as far as I’m concerned it’s pretty much the same as buying Goldman directly.”

The notes will be guaranteed by Goldman Sachs Group, according to the prospectus.

“Why did they set up the deal this way? It’s an accounting question. I don’t know why they’re doing this. They were probably able to get more competitive terms while still doing the deal under the Goldman Sachs banner,” said Balcom.

McCoy was more cautious.

“The GS Finance entity is the issuer for a reason. You would have to imagine that they’re using a subsidiary to protect Goldman Sachs from a threat or something going wrong,” he said.

“It’s set up that way probably to prevent Goldman Sachs from suffering losses.

“They may be guaranteeing the notes, but we’re still taking the risk of GS Finance as investors.

“Something goes bad and Goldman can just set GS Finance adrift.

“I’m not sure why they’re doing it that way, but you would have to take a hard look at what happens if the debt blows up. If you are a debtholder of GS Finance, you’re taking on the debt risk of GS Finance.”

Goldman Sachs & Co. is the underwriter.

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