GS Finance’s leveraged buffered notes on Core S&P Small-Cap ETF show rarely used underlier

By Emma Trincal

New York, Feb. 20 – GS Finance Corp.’s 0% leveraged buffered ETF-linked notes due Feb. 19, 2027 tied to the iShares Core S&P Small-Cap ETF give investors exposure to the small-capitalization market through a rarely employed underlier as an alternative to the widely used Russell 2000 index.

If the ETF return is positive, investors will receive par plus 150% of the ETF gain, subject to a maximum payout of par plus 35.3%, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF return is flat or falls by up to 20%, investors will receive par. Investors will lose 1% for every 1% decline beyond 20%.

Fundamentals twist

“We see notes on the Russell 2000 all the time. But this ETF is not very common,” said Tom Balcom, founder of 1650 Wealth Management.

The iShares Core S&P Small-Cap ETF tracks the S&P SmallCap 600 index.

“We like the S&P SmallCap 600. It has a selective methodology. We like the focus on financial viability,” he said.

The S&P SmallCap 600 index is composed of small-cap companies that “meet investability and financial viability criteria,” according to S&P Dow Jones Indices.

The constituents – companies with market caps between $900 million and $5.8 billion – must have positive earnings over the last four quarters and satisfy some liquidity and public float requirements.

Not common

The use of the iShares Core S&P Small-Cap ETF in a structured note is extremely rare, at least as a sole underlier. According to data compiled by Prospect News, only five deals have priced on this asset (excluding worst-of) for a total of $13 million.

The largest one came from JPMorgan Chase Financial Co. LLC, which sold $8 million on this ETF in September 2020.

Credit Suisse AG, London Branch, shortly before its demise priced two deals in January 2023. The Swiss bank was bought by UBS two months later.

Risk-reward

“The 35.3% cap looks pretty good, although it depends on your view,” said Balcom.

“Small caps have underperformed large-caps. If you think they’re due for a big rebound, you wouldn’t want a cap.”

The 35.3% maximum return over three years represents an annualized compounded return of 10.6%.

Balcom said this level was attractive given the other terms.

“First you get 1.5x the upside. It helps if the index goes nowhere.

“If you get 10% or 11% a year, the client can’t get too upset. They get a 20% buffer in exchange, and that’s a pretty substantial size for a buffer.”

Balcom said he always educates his clients about tradeoffs.

“If you want that level of downside protection, you have to accept the idea of capping the upside.

“Most clients understand that, unless the cap is ridiculously low, which is not case here,” he said.

Balcom said he liked the notes.

“These metrics are great. You’re getting pretty good terms,” he said.

Russell 2000 alternative

A financial adviser also said he has not seen the ETF in a structured note before.

“It’s a bit more concentrated than the Russell. But unlike the S&P 500 where Microsoft and Apple have a huge percentage, there is no holding in this ETF that dominates the index,” he said.

There are 665 holdings in the ETF.

Cytokinetics Inc., the top constituent, has a 0.66% weighting.

Microsoft Corp. and Apple Inc., the top two holdings in the S&P 500 index, have a combined weighting of 13.5%.

“It’s a new ETF for me. I mean I haven’t seen it in a note before,” he said.

“But I’m very familiar with it.”

Lacking the historical data for the iShares Core S&P Small-Cap ETF, this adviser used the Russell 2000 index to conduct his back-testing analysis.

Downside

Over a three-year rolling period, the Russell 2000 index has finished negative 12.7% of the time, he noted.

A negative return at or above the 20% buffer level occurred 7.3% of the time, while the “breach” of the buffer showed a 5.4% frequency.

“If it was an 80% barrier, I wouldn’t risk losing money 5.4% of the time. But you have a hard buffer. Even if the price drops more than 20%, you’re going to outperform,” he said.

“You’re pretty covered. The 20% buffer is good.”

Upside

On the upside, the back-testing returned a 45.8% chance of finishing below the cap. But 41.5% of the time, investors would be “capped out,” as the price would rise above the cap.

“Almost half of the time, you’ll outperform on the upside.

“On the downside, you will always outperform because of the buffer,” he said.

Adding up the probabilities gave investors a nearly 60% chance to outperform the underlying.

Based on those results, the adviser said the risk-adjusted return was satisfying.

“Unless you’re a roaring bull, to get on a three-year a cap that is that high with that level of downside protection is really not bad,” he said.

“You take equity risk, but with a potential gain of 10% a year, you’re getting some equity-type of return.

“It has the leverage, which should be very helpful if the market is lukewarm.”

In your favor

The prospectus did not state the fee.

“That’s one thing. I wish we would have that information,” he said.

“But overall, I could make a pretty strong argument that this is a decent note.

“For a client nervous about the market, it’s a good way to stay invested in small-caps. You have a limited upside, but you also have a 60% chance of beating the index. The odds of making money are in your favor.

“I’d give this one the thumbs up. I like it.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes were set to price on Feb. 15 and to settle on Feb. 21.

The Cusip number is 40057YCM3.

© 2015 Prospect News.
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