GS Finance notes offer three-year play on U.S. markets based on small versus large cap bet

By Emma Trincal

New York, Jan. 24 – GS Finance Corp.’s 0% index-linked notes due Jan. 24, 2025 linked to the S&P 500 index and the Russell 2000 index provide leveraged capped exposure to the least performing of the two main U.S. benchmarks over a three-year term. While an adviser is comfortable with the terms especially the tenor of the notes, another sees little appeal in capping the upside.

If the return of each index is zero or positive, the payout at maturity will be par plus two times the return of the least performing index, subject to a maximum payout of par plus 43%, according to a 424B2 filing with the Securities and Exchange Commission.

If the least performing index falls by up to 30%, the payout will be par. Otherwise, investors will lose 1% for every 1% decline of the worst performing index.

Economic worries

“It’s a tempting note. I typically don’t love worst-of, but these are two U.S. equity benchmarks. You’re just playing large-cap versus small-cap,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“As always, your decision is going to depend on what your market outlook is.”

While Kunhardt’s outlook, especially on the Russell 2000 index, is negative short term, it is bullish over the three-year span.

“Right now, small-cap would have me concerned. We’re not heading in the right direction,” he said.

“Inflation, persisting supply chain issues, the labor shortage...all these things create significant risk.

“If it was a 12-month, I wouldn’t go for it.”

Full cycle

But the notes will mature in January 2025 after two important Elections – this year’s midterm and the Presidential Elections of November 2024, he noted.

“Three-year is almost a full market cycle. I think by then, the economy should be in a much stronger footing,” he said.

“Here’s my personal opinion: if we’re going to have a recession and a bear market, it’s going to happen this year.

“The current economic policies, in particular the trillions of dollars of government spending, are generally considered to be inflationary. A lot of those policies are acting as headwinds.

“But by the end of the year, it’s very likely that the current majority is going to lose Congress.”

Less is more

The ensuing “paralysis” under this assumption would benefit the market, he predicted.

“Congress won’t be able to do anything. They can vote bills and the president can veto them.

“We’ll have a divided government and that’s a good thing.

“Whenever Washington is divided with one side controlling Congress and the other, the White House, regardless of whether the president is a Democrat or a Republican, the economy and the market do well.”

Many fundamental factors should support a strong economy as well, he noted.

“Coming out of the pandemic, there is a lot of pent-up demand. People have money to spend. More spending is a recipe for a surging economy,” he said.

S&P exposure

While Kunhardt is pessimistic about small caps, he sees a reversal at the end of the term.

“Small-caps lead you into recessions and they also lead you out of recessions.

“The S&P 500 will probably be the worst-of in three years.

“But since they’re both U.S. indices and as the economy by then should be recovering nicely, it doesn’t really matter.”

“You’re giving me exposure to the S&P with a 12% return and a 30% protection in three years? I’m all over that.”

Unnecessary barrier

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, had a more critical point of view.

“I don’t love this note,” he said.

“While I like Goldman Sachs as a credit, three years is at the outer edge of the duration we like to have, which is between one and two years.”

Protection should only be granted when the odds of using it are real, he added.

“On a three year, I don’t need a lot of downside protection because it’s unlikely that either the Russell or the S&P would be down.

“I would rather have a small buffer, for instance a 10% buffer over three years; that way, you know you have the absolute protection. With the barrier, you suffer the entire loss.

“[The 10% buffer] may be cheaper, or it may not. It would be worthwhile exploring what pricing you can get on a 10% buffer versus the 70% barrier.”

No cap

But Foldes’ main objection to the note was the upside.

“Whoever considers this note has to be bearish on these indices or very modestly bullish,” he said.

“You get two-times leverage, which is nice, but with a pretty severe cap of 43% on the worst of the two.”

The cap represents a 12.65% return on an annualized compounded basis.

While such return is “not too far” from the historical average, historical averages can have “huge swings,” he said. “Annualized returns over the past three years were significantly more.

“I wouldn’t want to be locked in.”

In general, Foldes seeks full upside participation.

“Someone choosing this note would rather be capped out for the benefit of the leverage and the barrier.

“I would rather let the market do what it’s going to do,” he said.

Contrarian view

This adviser admitted that his outlook did not match the pessimistic bias of most analysts and strategists on Wall Street.

“Forecasters are predicting lower returns for the next 10 to 20 years. But these are the same people who had very modest return forecasts for 2021. And look at what 2021 turned out to be? The S&P closed out the year with a 27% gain.

“I don’t give a lot of weight to forecasters because they’re often wrong.

“Three years out of three, the market is up. Why limit your upside?”

Redesigning it

If he had to reconstruct the notes, Foldes’ first goal would be to eliminate the cap altogether.

“I would need uncapped gains. Since I don’t think you need a 70% barrier over three years, I would first get rid of the downside protection either partially or entirely. That way, I would free up some options money.”

If this was not enough, he said he would be willing to decrease the amount of upside leverage.

“I would have to see what the terms are if I take the multiple down to 1.5 or 1.25 times,” he said.

“But the structure as it is with a long tenor and this cap would not meet my investment criteria.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes are expected to settle on Tuesday.

The Cusip number is 40057KSW4.

© 2015 Prospect News.
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