GS Finance’s $614,000 notes on Russell 2000 offer high leverage, hard buffer

By Emma Trincal

New York, Sept. 21 – GS Finance Corp.’s $614,000 of 0% leveraged buffered index-linked notes due Sept. 18, 2026 tied to the Russell 2000 index give investors an above-average leverage with a buffered protection. Advisers, however, compared the very small index growth required to reach the cap with the high leverage factor, and noticing a gap, expressed disappointment.

If the index return is positive, the payout at maturity will be par plus 2.94 times the index gain, up to a maximum payout of par plus 40%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes flat or falls by up to 15%, investors will receive par. Investors will lose 1% for every 1% decline beyond 15%.

Modest expectations

“It’s a pretty straightforward note. But the leverage brings it to the cap too quickly,” said Steve Doucette, financial adviser at Proctor Financial.

Over three years, the maximum annualized return on a compounded basis is 11.87%. Such result can be achieved if the Russell only goes up 4.35% a year.

“You need that much leverage when you really have low expectations. In three years, we don’t know where we’re going to be. But I don’t think it’s going to be that low,” he said.

Doucette said he would be willing to reduce both the leverage and the buffer size in order to increase the cap.

“I could do 2x on the upside, cut the buffer to 10% and see where the cap goes,” he said.

Leverage optics

This adviser holds the small-cap benchmark in his portfolio, which could make the notes useful.

“We have a small-cap exposure. Everyone does,” he said.

“This might be a good way to take some of your small-cap exposure and replace it with this note. That way you outperform, at least on the downside.”

Doucette said that too much leverage can sometimes cause clients to be disappointed as it raises expectations.

“You could be up a lot with 3x. Let’s say your client reads his statement at the end of year two. He’s up a lot in two years. But on the last year, the market drops. Now he’s no longer up a lot. He’s up a lot less. You’re going to get a lot of questions,” he said.

Reshuffling the note

“I would have to raise this cap. The market only has to go up 4% a year. You don’t need to be in a note for that.”

The first step would be reducing the leverage.

“I don’t think I need 3x leverage. Too much leverage is greedy.

“And on the downside, how important is a 15% buffer over a three-year period? I’m going to take 10% and see what happens to the cap,” he said.

Finally, the use of a worst-of could accomplish the same goal.

“We always get better outcomes with multiple indices. It doesn’t always simplify the asset allocation, but you get much better terms. If you do it large-cap/small-cap, you’re not adding too much risk,” he said.

The structure offered the advantage of simplicity.

But it would have to be changed.

“I see too much leverage and not enough potential gains. I would turn this around,” he said.

Almost bearish

Matt Medeiros, president and chief executive of the Institute for Wealth Management, expressed a similar criticism.

“I don’t like the cap. With so much leverage I would have expected a higher cap,” he said.

“I guess it reflects the view of the investor. You almost have to expect a pullback followed by a bounce back.”

In that scenario, investors do not need a very high maximum return.

“If you’re slightly bearish to modestly bullish, that leverage is efficient. But if that was my outlook, I would not want to hold a note for three years. I would avoid it altogether,” he said.

ETF alternative

Medeiros said that he would be inclined to buy an ETF, even a leveraged ETF, rather than the notes.

“I would sacrifice the buffer and I would have to accept the leveraged exposure on the downside,” he said.

“But I would feel much more comfortable. I can get out of an ETF anytime.”

The notes would deter any investor with a bullish view on the Russell 2000, he added.

“I have a higher expectation for the Russell. The index has been beaten up. Over the next three years, you could be so easily capped out,” he said.

Even for non-bullish investors, the notes did not entirely fit the bill, he said.

“Let’s say the client is skittish. There are a couple of ways to be cautious. You either minimize your exposure or you maximize your flexibility,” he said.

Risk management

The leverage remains relevant to minimize the exposure. A 5% allocation in a portfolio can be achieved by investing 2.5% with double exposure to gains.

“The leverage is not the problem. The leverage helps me reduce my position size.,” he said.

“Flexibility,” is a priority for this adviser.

“If I want more flexibility, I buy the ETF. That way, I don’t have to worry about liquidity.”

A note would have to offer enough advantages to offset the reduced liquidity of a structured note.

“The real advantage is the 15% buffer. That’s the pro,” he said.

“The con is that I have to hold the notes for three years.”

An alternative would be to keep the note but raise the cap.

“If I could do that, it would be a move in the right direction. I would weigh the higher return potential versus the flexibility,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on Wednesday.

The Cusip number is 40057WAD9.

The fee is 0.75%.

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