GS Finance’s leveraged notes on index basket offer bull play, but terms seen as too vague

By Emma Trincal

New York, Feb. 22 – GS Finance Corp.’s 0% leveraged basket-linked notes tied to international indexes offer a diversified bullish leveraged bet, but one adviser said the terms were not specific enough to make an informed decision.

The basket consists of the Euro Stoxx 50 index with a 36% weight, the Topix index with a 29% weight, the FTSE 100 index with a 16% weight, the Swiss Market index with an 11% weight and the S&P/ASX 200 index with an 8% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The expected term of the notes will be 24 to 27 months.

If the final basket level is at or greater than the initial basket level, the payout at maturity will be par of $10 plus 138.5% to 148.5% of the basket return.

If the final basket level is negative, investors will lose 1% for every 1% that the basket declines from its initial level.

Fee, dividends

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, said the note was essentially “very bullish” in part because of the uncapped return.

“It’s a play on developed markets, especially Europe. The leverage between 38% and 48% is nice.

But you’re giving up – I’m just guessing – a 2.5% dividend and you don’t know how much you pay for the notes,” he said.

The fee was not disclosed in the prospectus.

The exact participation rate and the term of the notes will be set at pricing.

The estimated dividend yield of the basket is approximately 2.3% based on current dividend yields for the index components or their ETF equivalents.

Assuming a 27-month tenor, investors would give up 5.17% in dividend.

“I like the underlying basket. We invest in international markets although we prefer emerging markets and Asia. This basket is more of a proxy for the EAFE index. It’s more concentrated than the index but it’s still fairly diversified,” he said.

Breaking even

The notes were not designed for investors expecting a sideways or down market, he noted.

“You have to be bullish for this trade. That’s because of the unprotected downside, but mostly it’s because you need to be able to offset the loss of dividend. The fee, regardless of what it is, is already built in. But you have to make up for the yield. We don’t know what the final leverage and the exact term are going to be. It makes it difficult to invest when you don’t have the specifics,” he said.

Investors should expect a relatively high minimum return to “break even,” he said.

“You need to get at least 10% in order for this thing to make sense. Otherwise, you’re better off buying the basket directly and collect the dividends.

“So, you need to be very bullish especially on European stocks.”

Sixty three percent of the basket is allocated to the European equity markets, which include the euro zone, the U.K. and Switzerland.

Guesswork

Carl Kunhardt, wealth adviser at Quest Capital Management, said he could not invest in the notes.

“I don’t know what the investment is. There is not enough information there to do proper due diligence,” he said.

“We don’t know the maturity date of the note. We don’t know when it’s going to price. We don’t know the cost. I could never present that to a client.”

The structure itself was not enticing, he added.

“This is just a leverage play. The fact that there is no buffer or barrier, even though there is no cap, is a big problem,” he said.

Tradeoff

Kunhardt likes to invest in notes providing a certain level of downside protection.

An outright investment in equities was a more reasonable option for this adviser, who said he was not comfortable with the “tradeoff” offered by the structure.

“I can buy the five ETFs with no ticket charge because it’s an advisory account,” he said.

“If I build my own portfolio using ETFs, I’m much better off. At least I know my parameters, my cost, my term.”

While the notes offer the benefit of asymmetric leverage, Kunhardt said it did not matter much to him.

“I typically don’t do leverage. I’ve never seen leverage play out well. And if I wanted to use leverage, I could just buy call options on my ETFs.”

But the main sticking point was the scarce information about the terms.

“You’re not capping me, but how do I know what the return on my investment is going to be?

“I can’t make any informed decision here. If you don’t know how long you’re investing for and for how much, you just can’t do a cost/benefit analysis.

“I’m not going to take a leap of faith when I invest for my clients,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The Cusip number is 40057FJY1.

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