GS Finance’s buffered basket-linked notes on indexes seen as too long both for bulls and bears

By Emma Trincal

New York, Nov. 19 – GS Finance Corp. plans to price 0% buffered basket-linked notes due Nov. 24, 2026 linked to an equally weighted basket of three indexes, according to a 424B2 filing with the Securities and Exchange Commission.

The basket consists of the S&P 500 index, the Euro Stoxx 50 index and the Russell 2000 index.

The payout at maturity will be par plus 1.36 times the basket gain with a maximum payout of par plus 60%.

Investors will receive par if the basket finishes flat or falls by up to 15% and will lose 1% for every 1% decline beyond 15%.

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, did not find the terms attractive.

Cap

“I don’t love this note. Number one, it’s way too long,” he said.

“I don’t like a cap on a five-year because you’re limiting yourself too much. The return you’re getting is below the historical average. It’s not beneficial to your client. You’re likely to underperform the index.

“We strive to keep our notes under two years. But if I did buy a five-year note, I would want uncapped upside.”

Stretching the upside

There could have been ways to enhance the upside for a bullish investor, he said.

“You don’t need a buffer on a five-year,” he said.

“The money spent on the protection is unnecessary. The likelihood of any of those indices to be negative after five years is very limited.

“I would much rather get rid of the cap altogether or increase the leverage, preferably both.”

Upside is OK

Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments, had a different market outlook. His main concern was the market risk.

“The fact that it’s not a worst-of is a positive feature. But I would worry about the downside,” he said.

“Just because it’s a five-year note doesn’t mean there is no long-term risk.

“The basket can go down more than 15% over that time.”

Because Kaplan’s market view is bearish, the cap was not an issue for him.

“The cap is debatable. But I don’t even think it will come into play,” he said.

“Those structured notes are not intended for bullish investors anyway. People in that space look for something a little bit conservative.”

Overstretched valuations

And yet, despite the buffer, the note lacked the characteristics of a defensive play, according to this portfolio manager.

“My main concern is that you’re buying a note at a time when the market is at such highs,” he said.

“Both the S&P and the Russell are extremely overvalued. The S&P is trading more than triple its fair value based on profits. The Russell is also close to three times what it should be trading at.”

The Euro Stoxx 50 index was not as expensive as the U.S. benchmarks, he noted.

“But it’s far from being a bargain. I would say it’s moderately overpriced.”

Since it only takes one of the indexes to drag down the performance of the notes, Kaplan identified the risk as associated with the U.S. indexes.

“The level of overvaluation in the U.S. markets is unprecedented. The chances of a market drop in excess of 15% are extremely high even over a five-year period,” he said.

He said that a market decline of two-thirds over the first two or three years was possible.

Opportunity coast

“Even if you have a rebound following that crash, even if the market doubles after that, you’re still going to finish a third lower.”

A less dramatic scenario could occur if the worst-performing index finished negative but above the buffer threshold.

“In that case you don’t lose any of your principal but haven’t earned any profit. You’ve wasted five years. That’s not a good outcome for investors,” he said.

Buffer, call

The terms of the notes could be modified to reinforce the protection.

“Unless you expect the same returns as those we had over the past decade, I don’t think you should worry about being capped at 10% a year.

“Instead, I would probably lower the leverage a bit and use that for a bigger buffer,” he said.

Kaplan also believed that the term of the notes was too long, pointing to the liquidity risk.

“You’re not getting any income for five years and you pretty much have to hold the notes during that time.

“I’d rather have an autocall. At least I’m getting a coupon in the interim and my duration is likely to be much shorter,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes were expected to price on Friday and to settle on Nov. 24.

The Cusip number is 40057K6E8.

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