GS Finance’s trigger gears linked to iShares MSCI EAFE ETF offer value for bullish investors

By Emma Trincal

New York, Aug. 28 – GS Finance Corp. plans to price 0% trigger gears due Aug. 31, 2020 linked to the iShares MSCI EAFE exchange-traded fund, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are guaranteed by Goldman Sachs Group, Inc.

If the ETF return is positive, the payout at maturity will be par of $10 plus 1.47 to 1.57 times the gain. Investors will receive par if the ETF declines by 20% or less and will lose 1% for each 1% decline from the initial level if the ETF declines by more than 20%.

Europe

“I like these notes,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

A lot of the appeal comes from the underlying asset class, he noted.

The fund tracks the MSCI EAFE index, which represents the performance of developed markets excluding the United States and Canada.

“You’re always going to invest in it in your portfolio if you’re asset allocating. If anything, international equity is underweight in most advisers’ portfolios.”

Kunhardt is particularly interested in the MSCI EAFE fund due to the large representation of European equity markets.

While the top country allocation in the ETF is Japan with a 23% allocation, most of the portfolio consists of European equity, which represents 62% of the total. This dominant sub-group is essentially made of euro zone members, with the exception of Switzerland, and the United Kingdom, which has the second largest weighting with 17%.

Upside

“You have 1.52 times leverage. You’re benefiting on the upside. The index can go up a little bit and you have no cap. This is the ideal payout if you’re bullish,” he said.

Kunhardt said that he is bullish on the European stock market.

“Based on valuations, they tend to lag the U.S. markets by three to five years. The value European equity offers is more attractive than the S&P and the Dow.”

The downside is also attractive.

“You do have the barrier. You could be down more than 20%. But in that though, if you breach you go back one-to-one from the original price, [and] you’d be exposed to that anyway if you were long the ETF.”

Cost

Another positive aspect of the deal is its cost structure. There is no fee, according to the prospectus.

“Goldman Sachs & Co. LLC expects to sell all of the notes to an unaffiliated dealer at 100% of the face amount of the notes,” the prospectus stated.

“The dealer will sell the notes to fee-based advisory accounts for which it is an investment adviser and will not receive any sales commission relating to these sales,” according to the filing.

“I’m not sure exactly how it works. I know that in some cases the adviser pays the brokerage fee, but there is no fee listed,” said Kunhardt.

“In any event, for independent advisers who charge their clients a flat fee, this is advantageous.

“I would think this deal was a reverse inquiry.”

Kunhardt, who buys his structured notes off the Raymond James platform, said he wishes the notes would be available to his firm.

Mostly positive

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, was in general positive about the notes.

“Finally a good one,” he said.

“The notes appear to be quite attractive. I would just have a few comments.”

Advisory fee

His first comment was about the fee.

“Nothing wrong here except that I don’t understand how the fee works. Goldman Sachs is not a philanthropic institution. I don’t see how there can be no commissions. They expect to sell 100% [of] face value without receiving any commission,” he said.

“I’d like to get under the wrapper and find out how they make money. That’s just a question.”

Fees are often waived for independent registered advisers as they charge their own clients a fee based on assets under management. The issuer in this case would get paid from the spread built into the notes, which is disclosed under the estimated initial value of $9.50 per $10.00 principal amount, according to the prospectus. It remains true that the adviser is not paying a sales commission to the issuer or the dealer.

Credit, tenor

His second comment was about credit risk.

“Goldman Sachs is an acceptable credit. It’s not the strongest in the U.S., but it appears that U.S. banks as well as European banks continue to tighten, and that’s a good thing.”

The five-year credit default swap spreads of Goldman Sachs are 70 basis points, according to Markit.

Morgan Stanley shows 65 bps while both Bank of America and Citigroup are at 55 bps, JPMorgan at 51 bps and Wells Fargo at 47 bps.

The three-year tenor of the notes is acceptable, said Foldes.

“Although this is a little longer than what we usually do, it’s not way out of the ballpark.”

Trade-off

Foldes always considers the amount of “unpaid” dividends when analyzing a structured note as it is part of the overall trade-off.

The shorter the duration, the lower the opportunity cost.

The iShares MSCI EAFE ETF has a 2.48% dividend yield. Over a three-year period, investors in the notes must forego a 7.60% compounded return, a gain that the shareholders would receive.

“What are we getting for giving up almost 8% over the period? We’re getting a 1.5 times leverage. That’s one of the reasons I like this note,” he said.

“The MSCI EAFE is cheaply valued. Hopefully three years from now we’ll see a nice appreciation.

“Many commentators are recommending exposure to this asset class. It is expected that this index has room to run.

“Getting 1.5 times is very attractive, and being uncapped is a nice situation.

“Similarly, having an 80% barrier is significant. Even though it’s unlikely that the index would decline by 20% over three years, it’s still very nice to have the protection.”

Buffer

Foldes said that if he were to consider the notes, he would probably try to replace the 80% barrier with a hard buffer.

“We would drill deeper what a buffer would look like versus a barrier. We would make a business decision based on the size of the buffer with the understanding that it would be smaller than 20%,” he said.

In conclusion, he said that the notes offer notable benefits.

“It’s a very attractive note. You’re getting significant leverage which is uncapped for a good credit and on a reasonable period of time.

“You still have the credit risk exposure and the loss of 7.6% worth of return.

“But when they can offer these kinds of terms, the notes remain very attractive.”

Goldman Sachs & Co. LLC is the underwriter.

The notes will settle on Aug. 31.

The Cusip number is 36253M547.

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