GS Finance’s worst-of on iShares EAFE, Euro Stoxx show high multiple, low barrier, no cap

By Emma Trincal

New York, Feb. 22 – GS Finance Corp.’s 0% underlier-linked notes due Feb. 27, 2023 linked to the iShares MSCI EAFE exchange-traded fund and the Euro Stoxx 50 index offer unusually attractive terms, advisers said, attributing them to a recent increase in the dispersion between the two underlying and possibly the long tenor.

If the return of each underlier is zero or positive, the payout at maturity will be par plus 3.12 times the return of the lesser performing underlier, according to a 424B2 filing with the Securities and Exchange Commission.

If either underlier falls but the return of each underlier is at least negative 45%, the payout will be par.

If either underlier falls by more than 45%, investors will be fully exposed to the decline of the lesser performing underlier.

The notes are guaranteed by Goldman Sachs Group, Inc.

Barrier

“The risk-reward I’m getting on that note is pretty attractive. You get more than three times up, uncapped. That’s pretty good,” said Jason Barsema, president and co-founder of Halo Investing.

The downside protection with a 55% barrier was also impressive.

“I’m not overly concerned about breaching the barrier. If you have a pullback of that magnitude, correlations go to one. If the EAFE is down 45%, you would probably be more concerned about other portions of your portfolio with higher weights.”

Correlation move

One of the factors benefiting the structure was the recent dispersion seen between the two underlying.

“Long-term, the EAFE and the Euro Stoxx are tightly correlated,” he said, stressing the overlay between the two benchmarks.

Recently however the correlation has been decreasing, he noted, which may partly be due to the impact of non-euro zone countries, which are included in the fund.

“This note takes advantage of an opportunity where the two aren’t as tightly correlated as they usually are, so that’s good!

“Less correlation adds a little bit more risk, which is what makes the terms better. You get a higher participation rate. It may have helped on the downside as well,” he said.

Europe

The two underlying tend to show a high correlation long term due to some overlap. Euro zone countries make for 53.5% of the MSCI EAFE index fund, according to the iShares website. The Euro Stoxx 50 index tracks the euro zone equity market.

The two largest weightings in the ETF however are not euro zone countries with Japan making for 24.31% of the fund and the U.K., 17.1%. Australia and Switzerland are also non-euro zone countries.

“I like it a lot as a tactical play within the portfolio,” he said, adding that he is bullish on Europe.

Barsema said that he currently has a 17% allocation to international developed countries.

“I could consider a 2% to 3% weight to that note.”

Leverage

Steve Doucette, financial adviser at Proctor Financial, was impressed by the terms as well.

“Look at this leverage: 3.12 times. And this barrier...The market can drop 45%.

“I’m surprised at how good the terms are. There must be some volatility in these indices,” he said, in addition to the additional risk induced by the worst-of.

In some cases, he added, a highly leveraged note can become burdensome however.

“Leverage works both ways. Say six months out, the market is up 100%. You’re up 300%. The client thinks they have a 300% return. Now the market turns and you just lost a whole lot of return.

“Leverage can be dangerous that way. Part of the issue is managing clients’ expectations.”

Tenor

The five-year term may be a concern as well.

“I do like the note. It’s just a duration thing. The 45% barrier is very conservative. That’s right. But who can tell what the market will be like in five years? We’re 10 years into a bull market. You never know,” he said.

As an improvement, Doucette said he would consider giving up one point of leverage for an additional 5% to 10% of downside protection.

“There’s a lot to like in this note. But as always, the term is the wildcard.”

Goldman Sachs & Co. is the underwriter.

The notes will settle on Tuesday.

The Cusip number is 40055AMF1.

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