Goldman’s PLUS tied to Topix index lack protection given slow growth, geopolitical risks

By Emma Trincal

New York, Sept. 10 – GS Finance Corp.’s Performance Leveraged Upside Securities due Jan. 3, 2020 linked to the Topix index fail to appeal to advisers due to their negative outlook on the Japanese market as well as Japan’s vulnerability to global trade tensions.

The notes at maturity will pay par of $10 plus 300% of any index gain, up to a maximum payment of $12.40 per PLUS, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for each 1% decline.

Value trap

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said he was skeptical about the economic and market outlook of Japan.

“We’ve heard for decades that Japan offers a unique opportunity because the value of its market has not been realized...and that it’s mispriced. People have said that Japan is a value play, but I’m afraid it’s been more of a value trap than anything else,” he said.

“Growth has been weak for decades and we have yet to see a rebound.

“They’ve been struggling with deflation issues despite a very stimulative monetary policy. If the market and the economy haven’t grown so far, I’m not sure what other remedy could successfully boost stock prices over the next 18 months.”

Sub-par performance

The potential leveraged return was attractive, he said, but not the unlimited market risk on the downside.

“It’s a pretty decent upside. But it could have been more attractive if they had included an absolute return... something that generates a gain even when the index is down as long as it’s within a certain range. That would have made a difference,” he said.

On an 18-month term the triple leverage up to a 24% cap generates an annualized compounded return of 18.8%, which can be achieved if the Topix index is up 8% per year.

But the performance of the Topix index was far from not encouraging, he said.

Over the past 10 years the average annualized total return has been 4%, according to Morningstar.

“And that’s with the use of a very aggressive economic stimulus,” he said.

He was referring to the policies of prime minister Shinzo Abe, who since his election in 2006 enacted a set of measures known as “Abenomics,” which consisted of using simultaneous monetary easing, fiscal stimulus and structural reforms.

“It’s definitely a bullish note with some decent upside potential. I’m just not as rosy about Japan’s economic outlook as many strategists are. In my opinion, it doesn’t make sense to be fully exposed to the downside on this asset class,” he said.

Other alternatives

Clemens Kownatzki, independent currency and options trader, said he was not sure why investors should use the notes versus an exchange-traded fund.

“There is no Topix ETF available to U.S. investors. That’s true. But there are probably 30 ETFs or more for Japan in various denominations and one of them is probably highly correlated to the Topix,” he said.

He was referring to the iShares MSCI Japan ETF.

“The vast majority of the top holdings are common in both,” he added, referring to the iShares ETF and the Topix.

“Take the top constituents of the Topix and the MSCI Japan ETF and compare: nine out of 10 are identical. We’re talking about exactly the same names: Toyota, Mitsubishi, Softbank, Honda etc.

“My guess is that there is a very high correlation between the Topix and the iShares ETF, probably around 0.9.”

Cost

This trader’s main concern was the risk-adjusted return of an investment that offers limited liquidity. The cost of putting together the product and selling it was also a drawback, he added, pointing to the 2.35% fee disclosed in the prospectus.

“I understand that it’s built in in the structure and that investors get par at maturity. But it’s still rich for a product that offers no downside protection,” he said.

Perhaps a lower fee would have provided better terms for the investor, he noted.

Risk-adjusted return

Kownatzki also pointed to Japan’s slow economy.

“Overall, Japan has shown a super anemic growth. Interest rates are negative and [quantitative easing] has helped somehow. But not enough,” he said.

“If you get negative return on anything fixed income you have to go to risky assets. So it has helped their stock market a little bit.

“But does that make me bullish over the next year and a half? I’m not sure.”

The leverage should help, however. For instance, even if the Topix grows by only 3% during the period, investors would pocket a 12% return.

“It seems attractive. The multiple is high and you don’t need to be very bullish. But I’m not comfortable having my upside capped while I’m taking all of the risk on the downside without a floor,” he said.

Trade wars

In addition to a sluggish growth that has characterized its economy for years, Japan is also at the mercy of geopolitical risks, he said.

“What if our president wakes up one morning and say: hey...we haven’t targeted Japan yet? It could happen next week. We’ve had Mexico, Canada and of course China. These are big hits. So why not Japan? Who knows?

“My point is not political. But there is just a high level of uncertainty in the global markets at the moment and that needs to be hedged,” he said.

Global slowdown

The risk of a global recession should also be taken into account.

“Economically they’re not standing on strong footing. Their growth still relies a lot on exports,” he said.

“What if the crisis in emerging markets intensifies? Japan exports everywhere: to emerging markets, to Europe.

“Europe itself is in the midst of a political crisis. There are ongoing tensions between a variety of countries – take Italy – with Brussels... the refugee crisis being the number one issue.

“If any of these markets slows down, Japan is going to be hit as well.”

Missing hedge

With all these risks and a “not so exciting” underlying asset class, Kownatzki said he would not consider the notes.

“Even if I had a bullish view, it might seem attractive. But I would have no way of hedging it.

“I would have to create the protection myself with options, which would drag down my performance.

“I don’t know if I would want to do that trade without protection,” he said.

Goldman Sachs & Co. LLC is the agent with Morgan Stanley Wealth Management as the dealer.

The notes are guaranteed by Goldman Sachs Group, Inc.

The notes will price on Friday.

The Cusip number is 36255U695.

© 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.