GS Finance’s notes tied to iShares EAFE ETF and iShares EM ETF offer allocation tool

By Emma Trincal

New York, Oct. 10 – GS Finance Corp.’s 0% notes due May 4, 2023 linked to the iShares MSCI EAFE exchange-traded fund and the iShares MSCI Emerging Markets ETF may allow investors to do better than an outright position in the equity fund with the caveat of the worst-of exposure, sources said.

If the final value of each fund is positive, the payout at maturity will be par plus at least 210% of the lesser-performing fund’s return, with the exact participation rate to be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If either fund declines, but both funds remain at or above 70% of their respective initial levels, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the lesser-performing fund from its initial level.

International bucket

Steve Doucette, financial adviser at Proctor Financial, liked the simplicity of the offering.

“It’s a neat, plain-vanilla note. But as always, it’s about timing. This one is three-and-a-half years out,” said Doucette.

Outperforming a benchmark in up and down markets is the reason why he buys structured notes in the first place.

“It’s a worst-of, so we don’t really know the exposure that we’ll get a maturity. But this is an asset class that has the potential to run. You can use it for your international asset allocation,” he said.

Cap, barrier

Doucette said the upside was the most straightforward part to analyze.

“You get 2.1 times and no cap. I like it. Yes, it’s tied to the worst index. But the leverage can boost the return,” he said.

“The only question on the downside is: will 30% give me enough protection over three years?

“If it doesn’t, you’re long the index. Sadly, it’s the worst performing one.”

Correlated funds

One fact may help: both international funds have been lagging the performance of the U.S. equity market over several years, he noted.

“Both the emerging markets and the developed markets funds should be down less than the S&P or up more,” he said.

“The emerging markets have been down a little bit more than the EAFE. Now they’re both coming back a little bit.

“Emerging markets took a big hit in August. Since then it’s lagging.”

The emerging markets ETF is up 5.15% so far this year versus 9.55% for the iShares EAFE fund. Both were down by about the same amount last year (15% for emerging markets and 14% for the EAFE). The bull market of 2017 showed a greater dispersion between the two with emerging markets soaring by 36.5% versus a 25% gain for the EAFE fund. During that year, the S&P 500 index rose by 22%.

Overall, the two international funds are highly correlated. Their coefficient of correlation is 0.85, 1 being a perfect correlation.

Catching up

“A lot of the folks have been discouraged with the performance of non-U.S. markets,” he said.

Over the past three years, the iShares emerging markets fund has gained 9% and the EAFE ETF has posted a 9.5% positive return. Meanwhile the S&P 500 index has returned 36.5%.

“That’s where I see some potential for outperformance. Invariably, reversion of the mean occurs,” he said.

“The potential for outperformance on the upside is pretty good, especially with the leverage and no cap.

“And they shouldn’t go down as hard as the S&P if things turn down.

“It’s a great way to take international exposure.”

China eyed

Matt Medeiros, president and chief executive officer at the Institute for Wealth Management, said he is relatively bullish on the emerging markets.

“Despite the trade issues with China and the fact that the fund has a high exposure to this country, we see opportunities in the emerging markets,” he said.

The continued trade war may lead multinational companies to flee China and move their manufacturing into other emerging markets, he explained.

“We’ve already seen this happen with Vietnam. If more emerging markets gain market share from China, the asset class as a whole will benefit, which should be a positive for the emerging markets fund.”

Sluggish Europe

Predicting which will be the worst-performing fund will depend on each fund’s volatility and the overall direction of the market.

“I like emerging markets. I’m a little bit more concerned with Europe,” he said.

The EAFE index fund has a more than 60% weighting in European stocks, which makes this ETF a close proxy to an exposure to Europe.

“Brexit is an issue but it may not be the main one. I think slow growth in the European Union is really the main concern. Economic data in Europe doesn’t suggest a pickup in growth any time soon.”

The likely losers

Medeiros noted that the emerging markets fund is more volatile than the EAFE ETF.

“It makes sense to imagine that in a bull market, the emerging markets would outperform while it would just be the reverse if the market is negative,” he said.

“As a result, the worst-of may end up being the EAFE, if the market is up. If it’s down, emerging markets would be the exposure.”

Up and down scenarios

The upside payout is helping investors, he said.

“Given our low return expectations on Europe, this worst-of would be attractive if the market is up. It gives you the leverage and the no-cap, which would boost the performance.”

If the market ends up negative, the barrier may prevent the losses.

“I think 30% should be enough. We are relatively bullish on this asset class. We don’t expect a significant decline three-and-a-half years from now. By then, especially on a point-to-point observation, the impact of China should be absorbed.”

Medeiros said the note provides an interesting asset allocation tool for advisers.

“I am intrigued for sure. If I was to buy this, I would put it in my international bucket as a tactical overweight to these asset classes,” he said.

Goldman Sachs & Co. LLC is the agent.

The guarantor is Goldman Sachs Group, Inc.

The notes (Cusip: 40056XGD2) will price on Oct. 31 and settle on Nov. 5.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.