GS Finance’s $1.42 million leveraged basket notes on energy stocks offer alternative to ETF

By Emma Trincal

New York, March 2 – GS Finance Corp. priced $1.42 million of 0% leveraged buffered notes due Feb. 13, 2023 linked a roughly equally weighted basket of 24 energy stocks, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket return is positive, the payout at maturity will be par plus 2 times the gain, subject to a maximum settlement amount of $1,560 per $1,000 of notes.

If the basket finishes flat or falls by up to 10%, the payout will be par. Otherwise, investors will lose 1.1111% for every 1% basket decline beyond 10%.

Goldman Sachs & Co. LLC is the agent.

Equally weighted

“I like it. If you look at the XLE, Exxon and Chevron together make for half of the portfolio. This note gives you the same stocks but it’s a much more diversified approach,” said Tom Balcom, founder of 1650 Wealth Management.

With “XLE” he was referring to the Energy Select Sector SPDR exchange-traded fund, which is listed on the NYSE Arca under that ticker.

The basket consists of the same component of the ETF. The difference is the equal-weighting exposure as each basket component has a weighting of either 4.16% or 4.17%. The basket consists of Apache Corp., Baker Hughes Co., Cabot Oil & Gas Corp., Chevron Corp., ConocoPhillips, Devon Energy Corp., Diamondback Energy, Inc., EOG Resources, Inc., Exxon Mobil Corp., Halliburton Co., Hess Corp., HollyFrontier Corp., Kinder Morgan, Inc., Marathon Oil Corp., Marathon Petroleum Corp., NOV Inc., Occidental Petroleum Corp., Oneok, Inc., Phillips 66, Pioneer Natural Resources Co., Schlumberger Ltd., TechnipFMC plc, Valero Energy Corp. and Williams Cos., Inc.

Pandemic casualty

Balcom liked the structure. The double leveraged exposure with a 56% cap offers a 24.9% annualized compounded return.

“You have a lot of potential return with such a cap. But it makes sense because the sector is highly volatile. You need to get paid for that. This is what justifies the 56% cap,” he said.

The Energy Select Sector SPDR has regained its level of a year ago just ahead of the big plunge of March 2020 when the fund hit its lowest in a decade as the Covid-19 pandemic hit, forcing shutdowns and grounding planes.

At a $49 a share closing price on Tuesday, the ETF has more than doubled from its bottom of March 18 but remains nearly 20% lower than at the beginning of last year.

The implied volatility of the Energy Select Sector SPDR ETF is 41%.

“While the diversified basket reduces the volatility, you’re still in a volatile sector,” he said.

Recovery play

Balcom said the notes allowed investors to bet on the post-Covid economic recovery.

“You can use it to capitalize on the rotation from tech to energy or from tech to the sectors that have been beaten up during the lockdowns. Once we return to a more normal world, with the vaccines and the pandemic under control, we’ll see more travel, more demand for energy. This is a bet on an improved economy,” he said.

The same bet can be played with the ETF but at a greater risk.

“This basket gives you the diversification. The SPDR is too concentrated around big oil stocks. You’re taking less risk with the equal-weight strategy,” he said.

Investors have been using the same technique to get exposure to developed markets in place of the MSCI EAFE index via unequally weighted baskets made of international equity indexes. Issuers recently have also offered notes linked to the S&P Equal Weight index in order to avoid the over-exposure to tech stocks of the S&P 500 index.

High cap

Donald McCoy, financial adviser at Planners Financial Services, said the terms were enticing even for a bullish investor given the height of the cap. However, the volatility was a concern.

“They’re enticing you with the 2x leverage and the buffer. The only reason you wouldn’t do this note is if you thought the stocks were going to take off and get a huge ride. You’d have to think you could do better than 56% in two years so you would have to be pretty bullish,” he said.

However, 56% in two years is not inconceivable in this sector of the stock market, he noted. Investors may enjoy high returns by taking a long position in the ETF, which is already up 42% for the year, according to Morningstar. Last year, however, the fund was down 36.45%.

Erratic returns

“I think the issue here is the volatility of energy in general and how difficult it is to time the trade,” he said.

“This is a sector that has good years followed by terrible years. The two-year term gives you the opportunity for a recovery in energy. But you could just as well see a bloodbath.

“If you have a good year, you can get 30% in that year alone. But you have to make sure you’re in the right cycle.”

The fund posted four consecutive years of negative returns from 2017 to 2020. In 2018, the fund dropped more than 28%. The best performance over the past decade was in 2016 with a 38.28% gain.

Boom and bust

The equally weighted basket was designed to reduce the volatility associated with the ETF, which was an advantage, he noted.

The 10% buffer was also beneficial to control some of the risk.

Still the notes were not for everyone.

“This is for aggressive investors who are confident taking a bet on energy,” he said.

“They know it’s a boom-and-bust play.

“Because there’s such volatility in this sector, you have to assume that at least one of the years will be positive and positive enough to offset the other year, which is likely to be negative. It’s a little bit of a merry-go-round.”

The notes are guaranteed by Goldman Sachs Group, Inc.

The notes settled on Feb. 11.

The Cusip number is 40057FGE8.

The fee is 0.425%.

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