GS Finance’s issues on MSCI Emerging Markets provide value, says contrarian portfolio manager

By Emma Trincal

New York, July 22 – GS Finance Corp. recently priced two offerings on emerging markets, which offer good prospects for investors due to their respective structures but also to the choice of an undervalued, unpopular underlying asset class, according to Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, who focuses on value investing.

The most recent deal for $1.22 million was a five-year digital note issue linked to the MSCI Emerging Markets index.

The payout at maturity will be the greater of par plus 55% and par plus the index return if the index finishes at or above its initial level.

If the index falls no more than 30%, the payout will be par. Otherwise, investors will lose 1% for every 1% that the index declines from its initial level.

A week before, GS Finance priced $1 million of four-year autocallable buffered notes tied to the same index.

The notes will be automatically called at par plus 20.5% if the index closes at or above its initial level on July 14, 2023.

If the notes are not called and the index return is positive, the payout at maturity will be par plus 130% of the index gain.

Investors will receive par if the index falls by up to 20% and will lose 1.25% for each 1% loss beyond 20%.

Two deals

“I very much like the minimum return of 55% in the first deal. Also, I like the fact that it is not capped. The other one has no cap at maturity, but if you get called, your return is limited to the call premium. It’s not a bad scenario though given that they pay 20.5%, which is very good. And if you’re not called, the 1.3x leverage is great as well.”

Kaplan compared the two types of protection.

While he usually prefers buffers to barriers, the 30% size of the barrier in the first offering gave ample safety for an undervalued asset class, he said.

Both protection mechanisms were attractive, the buffer itself being “generously” priced at 20%, he said.

Five or four

Kaplan then compared the tenors.

The five-year note appeared to be a safer play.

“If we have a bear-market bottom in 2024 or 2025, then a five-year note which extends to July 2027 will give the market enough time to fully recover. A July 2026 termination date might not be enough for a complete rebound, especially if we don't bottom until perhaps late 2024 or early 2025,” he said.

Post-bear bid

Regardless of the exact timing, emerging markets were likely to rally after a deep U.S. pullback.

“Emerging-market assets tend to outperform U.S. stocks following the collapse of a growth-stock bubble,” he said.

“We saw that most recently in 2002-2008 after the March 2000 QQQ drop of 83.6%, and similar behavior after the 1973-1974 bear market which was followed by emerging markets doing well into January 1980.

“QQQ” is the ticker for Invesco QQQ Trust, which replicates the performance of the Nasdaq-100 index.

A short duration could also work to the advantage of investors who bought the notes callable in July 2023.

“A year from now, we could bounce back given that we’ve been in a bear market since the beginning of the year,” he said.

“If you look at past bear market patterns, the most likely time for depressed valuations would be from roughly the spring of 2024 through the spring of 2025,” he said.

“A two- or three-year tenor would be much more problematic.”

Below Everest

Perhaps the most appealing part of both deals was the choice of the MSCI Emerging Markets index as the underlying, he said.

The MSCI Emerging Markets index is 28% off its February 2021 high.

But Kaplan said he does not base his analysis on prices.

“We know that the MSCI Emerging Markets is down a lot. But down from where?” he said.

“If you have an overvalued asset like QQQ, which hit an all-time high in November and is now 26% lower, it doesn’t mean the fund is cheap. It just means you’re now below Mount Everest,” he said.

“So many people buy stocks because they’re down 30% or 40%. They just watch the chart. You have to look at the fundamentals, especially fair value,” he said.

Good fundamentals

The current price-per-earnings ratio of the iShares MSCI Emerging Markets ETF, which replicates the index, is 11.26 compared to 27.74 for QQQ, he noted.

“The Emerging Markets ETF is a much better bargain,” he said.

The fund is also trading at fair value.

“Traditionally, fair value is when the annualized profit growth is identical to the PE. With the Emerging Markets ETF, it’s even slightly higher, which is good.”

China, U.S. dollar

Another factor making the fund cheaper is the high exposure to China. A third of the Emerging Markets ETF is allocated to this country, which has endured a big drawdown in the technology sector.

Technology or internet Chinese stocks such as Tencent Holdings Ltd., Alibaba Group Holding LTD. and JD.com, Inc. are among the top 10 holdings of the fund.

Finally, the appreciation of the U.S. dollar has put downward pressure on emerging markets shares.

“The strong U.S. dollar makes emerging market securities a better bargain. The worst time to buy them is when the dollar is bottoming,” he said.

The slowdown in Chinese economic growth and the war between Russia and Ukraine have also contributed to the unpopularity of emerging markets.

“You’re getting exposure to an asset class at a bargain. The two notes have reasonable terms and downside protection features.

“I may prefer the five-year one. But both seem like worthwhile deals,” he said.

The guarantor for each deal is Goldman Sachs Group, Inc., and the agent is Goldman Sachs & Co. LLC.

The digital index-linked notes (Cusip: 40057MN96) settled on Friday.

The autocallable buffered notes (Cusip: 40057MN70) settled on July 18.

The fee for both deals is 0%.

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