Goldman Sachs’ CDs tied to S&P 500 with quarterly return offer tradeoff for cautious investors

By Emma Trincal

New York, Jan. 12 – Goldman Sachs Bank USA’s 0% certificates of deposit due Feb. 1, 2021 linked to the S&P 500 index offer investors a minimum return of 6% over the term with the possibility of gaining much more from the market appreciation. But the quarterly calculation of the payout and the cap used on the same basis limit the odds of getting the full upside at the end of the term, according to financial advisers.

The payout at maturity will be par plus the sum of the index's returns in each of the quarters making up the life of the CDs, subject to a minimum return at maturity that is expected to be at least 6%, according to a term sheet.

The return will be measured from the end of the immediately preceding quarter to the end of the current quarter. The return in each quarter can be positive or negative and will be subject to a cap of 4.5% to 5%.

Range of gains

“Twenty-four quarters time 4.5%, that’s 108% divided by six years, an 18% annualized return approximatively without taking into account compounding,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“They offer you 6% minimum payout, or 1% per year.

“So your potential return per annum is between 1% and 18%. That’s not bad at all.

“But I don’t think you’ll ever get close to 18%.”

Breaking even

The term sheet explains how the quarterly calculation may limit the appreciation. As the return is based on the sum of the quarters, it will not reflect the performance of the index over the life of the CD, according to the term sheet.

“Even if the closing level of the index on the determination date exceeds the initial index level, you may not fully benefit from such increase,” the document warned.

The cap and unlimited downside applied to each quarterly calculation increase the chances of a negative or limited sum at the end, said Kunhardt.

“You have a 4.5% cap and no downside limit. So imagine a few bad quarters out of 24, and say you have at some point a 25% loss. It would take a gain of 33% to be back to even,” he said.

“Because returns are not calculated from the initial price, it may be harder to keep on going up quarter after quarter.

“No matter how you calculate it, if you’re down a set of quarters it’s a huge headwind to have the cap and no downside limit on each quarter. It makes it more difficult to get back to even.”

Protection tradeoff

Yet, Kunhardt defended the product as a solid instrument for conservative investors.

“At the end of the day you can’t lose,” he said.

“In essence, you’re not losing all the dividends, only a part of it.”

The dividend yield on the S&P 500 is 1.87%.

“It’s not an income product. You don’t get income. But you get to play the capital appreciation game while hedging the market and protecting your downside.

“This is the classic tradeoff – ‘I’ll give up my upside in order to protect my downside’. You sell a call option and use the proceeds to buy a put. That’s the rationale.”

What gave Kunhardt “pause” was the six-year term, which he said was a “really long time.”

However in the low interest rate environment, “they’re all doing long-term CDs out there.”

The CDs are insured by the Federal Deposit Insurance Corp., up to the maximum limit of $250,000.

“FDIC coverage is always a good thing although it covers you against credit risk, not against losses,” he said.

“I have done a bunch of CDs. That’s how I started with structured products: using market-linked CDs to hedge the risk away, but I was being challenged by the low yields, which is why I started to get into notes.

“I like CDs tied to a broad index, like this one. I would use benchmarks like the S&P or the Russell. I would stay away from the Euro Stoxx 50, which I find too volatile, or the Dow because it’s too concentrated. To me, it’s rolling the dice.”

Thomas Orecchio, president of Modera Wealth Management, saw limitations in the structure but agreed that the tradeoff may work for a certain type of risk-averse investors.

“It’s common to measure the return point to point, quarter to quarter. You find that in annuities too,” he said.

“I would look at the 6% minimum at maturity as a guaranteed 1% a year. That’s what you’re earning.

“People interested in the CDs are those who want to participate in the market but not experience the downside that you typically experience when you [invest] over a market cycle.

“I’m not a huge fan of those products. There are other limitations, things you’re giving up. For instance, you don’t get to enjoy the dividends. You get the appreciation from point to point but not the dividends. That’s 25% to 30% of the return of the stock market you don’t get to participate in. It’s a major limitation. Then you have the 5% cap.

“Six years is long enough to be in the market anyway. I would be more comfortable being long the index and getting full participation than limiting my upside and be in a CD.

“But that’s me.

“Others may be willing to give up the upside and get the protection and those are the investors the CDs were created for.”

Goldman Sachs & Co. is the agent. Incapital LLC is the distributor.

The CDs will price Jan. 27 and settle Jan. 30.

The exact minimum return and cap will be set at pricing.

The Cusip number is 38148D4N1.

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