GS Finance’s $68.5 million notes on sub-tech indexes show appeal of theme bets, innovation

By Emma Trincal

New York, Oct. 6 – In an attempt to capture more volatility for better terms, structured products issuers are increasingly using newly created indexes or ETFs that are subsets of already volatile sectors. Those efforts can prove successful.

Case in point: GS Finance Corp. priced last week $68.5 million of three-year index-linked notes tied to the PHLX Semiconductor Sector index, the MSCI ACWI IMI Fintech Innovation index and the MSCI ACWI IMI Cybersecurity Innovation index, according to a 424B2 filing with the Securities and Exchange Commission.

If each index finishes at or above its initial level, the payout at maturity will be par plus 1.3717 times the return of the worst performing index.

Otherwise, investors will lose 1% for every 1% decline of the least performing index.

“This is a very thematic play,” a market participant said.

Recent indexes

Two of the underliers are relatively new indexes.

The MSCI ACWI IMI Fintech Innovation index was launched on April 20, 2020 and the MSCI ACWI IMI Cybersecurity index, on Oct. 31, 2018.

The prospectus for the notes warns investors about the “limited operating history” of both indexes as a risk.

As the underlying indexes are focused on a specific segment of the tech sector, they show relatively high volatility levels.

The top constituents of the Fintech index for instance – Salesforce.com and Nvidia Corp. – have implied volatilities of 31.33% and 44.71%, respectively.

Fortinet, Inc., the top holding of the Cybersecurity Innovation index, has an implied volatility of 43.3%.

The Fintech index was developed in collaboration with ARK Invest, the company that created the series of highly popular actively managed ETFs such as ARK Disruptive Innovation, ARK Fintech Innovation and ARK Next Generation Internet just to name a few.

Thematic plays

“In the last few years, several issuers have launched products linked to subsets of the technology sector,” the market participant said.

“You are getting leverage with no cap. From a structuring perspective, you’re getting more volatility because the indexes consist of concentrated portfolios following one theme.

“Volatility increases the distribution of potential returns, which makes the optionality of the worst-of more valuable.”

On the heels of ARK

For this market participant, the use of “futuristic” indexes in structured notes can be attributed to ARK Invest’s chief executive, Cathie Wood, who pioneered the concept of “disruptive technology” ETFs in the creation of her ARK funds. Prior to founding ARK Invest, Wood was chief investment officer of global thematic strategies at AllianceBernstein.

“This thematic trend seen in structured notes lately has a lot to do with the success of ARK,” the market participant said.

Indeed, several issuers, including GS Finance, JPMorgan Chase Financial Co. LLC and Citigroup Global Markets Holdings Inc. have all priced large offerings of notes linked to ARK ETFs.

Other deals

The use of the two MSCI ACWI IMI underlying indexes (Fintech and Cybersecurity) seen in last week’s offering is more recent. But it has paid off, especially for Goldman Sachs, which has priced large deals on some of the MSCI ACWI indexes.

In the beginning of August, GS Finance priced $72.1 million of three-year notes linked to the least performing of the Nasdaq Next Generation 100 index, the MSCI ACWI IMI Cybersecurity index and the MSCI ACWI IMI Future Mobility index.

The structure was identical to last week’s offering with a leverage factor of 1.5276, no upside cap and full downside risk.

A month ago, GS Finance priced another three-year deal of uncapped leveraged notes with no downside protection for $55.79 million. Investors are exposed to the least performing of the Nasdaq Next Generation 100 index, the MSCI ACWI IMI Cybersecurity index and the PHLX Semiconductor Sector index. The upside leverage factor is 1.4771 and exposure to market decline, 100%.

Separately, Morgan Stanley Finance LLC since February has priced about $50 million in a few deals linked to the iStoxx Global Fintech 30 NR Decrement 5% index.

ETFs joining the fray

As a sure sign that investors have a strong appetite for “disruptive” or “futuristic” technology stocks, a few ETFs have recently launched tracking some of the indexes focused on this niche.

In January for instance, Bank of Montreal launched its BMO MSCI Fintech Innovation Index ETF, which is listed on the Toronto Stock Exchange. In October 2019, Global X rolled out its Global X Cybersecurity ETF, which tracks the Inox Cybersecurity index.

In June, Invesco Capital Management LLC created its Invesco PHLX Semiconductor ETF, which directly tracks the index of the same name.

Not ARNs

Uncapped leveraged return notes with no downside protection are not a novelty, in terms of structure.

One of the most common of such products are the 14-month Accelerated Return Notes on the S&P 500 index popularized by Bank of America.

The market participant compared the ARN-type of structure with last week’s offering.

“This one is a longer-dated note. You’re committing your capital for a longer period. You’re giving up more funding compared to a 14-month ARN,” he said.

“Also, the 1.37 times leverage is not that high. Most ARNs have triple upside exposure.

“Finally, none of these underlying indices pay high dividends, if any. So, from a pricing perspective, there’s not much benefit in giving up dividends.”

The worst-of feature helped pricing despite the overlapping investment themes between the three indexes.

“There’s still less than 100% correlation,” he said.

But one factor playing against investors was the 3.75% fee, he noted.

“Despite its appeal, I would say, it’s a flashy product. People gravitate around those New Age companies producing super cool technologies. Investors will buy it without thinking of the cost and the terms,” he said.

“It’s a very rich deal.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The Cusip number is 40057JQ33.

The notes settled on Oct. 1.

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