GS Finance’s digital notes on Stoxx 50 may mature too close to the Elections, adviser says

By Emma Trincal

New York, Dec. 10 – GS Finance Corp. plans to price 0% digital index-linked notes due June 16, 2021 linked to the Euro Stoxx 50 index, according to a 424B2 filed with the Securities and Exchange Commission.

If the index return is positive, the payout at maturity will equal par of $10 plus the greater of the return and the fixed payment percentage of 13.15%.

If the index falls by up to 25%, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline from the initial level.

The final price of the index is measured from the trade date to each of the averaging dates. Those are expected to be: June 7, June 8, June 9, June 10 and June 11, 2021.

Election risk

“The one thing I don’t like about the note is the term. It’s going to mature right at the time I expect the market to be at its lowest levels,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

“If the U.S. has a recession, the chances of being negative are high, even of being down more than 25%.

“The European market is not as overvalued as the U.S., but of course it will go down if we have a worldwide recession.”

The notes mature about six months after the U.S. Presidential Elections.

“Do we have a gridlock? Do the Democrats take over the presidency, in which case the perspective of higher taxes may scare a lot of people? Is the winner going to be Elizabeth Warren or a Buttigieg or Biden?

“Volatility is going to be so high that having something ending in June 2021 may coincide with a very low point.”

Post-Elections period may be volatile but followed by a recovery. It’s usually the case, he said. But his concern was there might not be enough time for the market to stabilize.

“The market dropped at the end of 2008 just before the Elections. But it really bottomed in March 2009 and hit a higher low just after that in July 2009,” he said.

“If we have a recession, picking a month six months after the Elections will be too close. We may not have reached a rebound.”

Fair terms

Kaplan did not object to the terms of the deal however.

“The way it’s structured isn’t too bad. Of course, I’d prefer a buffer to a barrier. But you still have some protection, which is a good thing,” he said.

“Of course, you give up the dividends. But you have a fairly decent return and there’s no cap so you can participate in a moderate uptrend.

“The timing is the most serious problem for me.”

FX neutral

Another issue, albeit less “serious,” was the fact that investors in the notes may not benefit from a weakening of the U.S. dollar versus the euro. Kaplan expects the dollar to depreciate versus the euro.

While linked to the Euro Stoxx 50, the notes, as all notes tied to foreign indexes, are settled in U.S. dollars through a quanto option, which removes the currency risk exposure. For investors betting against the dollar as Kaplan does, eliminating the currency leg of the trade would suppress some of the potential gains.

“And those gains can be substantial,” he said.

U.S. investors benefit from a conversion from foreign assets into a weakening dollar.

“It’s more of a problem to me than losing dividends. If the euro rises, which I expect, the performance of the Euro Stoxx may decline due to the negative impact a strong currency has on exports and the economy,” he said.

“If you bought the shares of the fund itself, some of this impact would be offset by the conversion into a weaker dollar, which would bring an additional source of revenues.”

Dividend trade-off

Tom Balcom, founder of 1650 Wealth Management, said he liked the notes for the downside protection.

“I’m always interested in a product that has a defensive edge to it. This one in particular gives you a minimum return. It’s not very high but you still have the upside participation with no cap.

“If we have a pullback, you’ll have the protection in place in there.”

The “loss” of dividends was part of the usual trade-off to gain protection.

“You’re not getting the 5% in dividends for the period. But you’re protected up to 25% on the downside, which is reasonable. I think you’re getting fairly compensated for giving up the dividends.”

The Euro Stoxx yields 3.4%.

Short-dated

Balcom said that he liked the short tenor.

“We like to do notes for three years or less. Eighteen months is nice. It allows you to rebalance your portfolio without having to wait too long.”

The uncapped upside was an important element as well.

“Having the minimum return is great if the market moves sideways. But it’s also nice to have the unlimited upside.

“Getting downside protection if there’s a pullback, while still being able to participate, makes for a great combination,” he said.

The notes will be guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

JPMorgan is the placement agent.

The notes are expected to price on Dec. 13 and settle on Dec. 18.

The Cusip number is 40056XVT0.

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