GS Finance’s $1.15 million autocalls on Momentum Builder show 9% yield, but calls step up

By Emma Trincal

New York, Nov. 15 – GS Finance Corp. priced $1.15 million of 0% autocallable notes due Nov. 11, 2024 linked to the GS Momentum Builder Multi-Asset 5S ER index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus an annual call premium of 9% if the index closes at or above its call level on any annual review date. The call level will be 103.25% of the initial level for the Nov. 12, 2018 review date, stepping up by 325 basis points on each subsequent call review date up to 119.5% of the initial level on Nov. 10, 2023.

The payout at maturity will be par plus any index gain. If the index falls, the payout will be par.

Momentum play

The index provides exposure to price momentum of several asset classes using a methodology developed by Goldman Sachs & Co., the index sponsor. The strategy combines 14 underlying exchange-traded funds across six asset classes and a cash equivalent. These ETFs are periodically rebalanced in order to cap the volatility of the portfolio at 5%.

Probability play

“The probability of a call gets lower as you move along because of the step-up,” said a market participant.

“On the first year, you’ll outperform this index if it’s between 3.25% and 9%.

“A 9% return would satisfy most clients.

Investors have small chances of outperforming the market, he said.

“The window to outperform on the first year is pretty narrow. While your potential excess return over the index increases with time the step-up reduces your probabilities of getting called at all.”

For instance, if the index was above 103.25% and less than 109% on the first year, investors could outperform in theory by up to 5.75%.

On the second year however, the index, which failed to move above the first call level a year before would have to rise to 106.5% in order for investors to receive the second call premium of 18%. In this case they would have the potential to outperform the index twice more than in the first year. But the probabilities of being called are greatly reduced, he said.

Principal protection

“It’s a probability play. You could get your 9% per year. Or you could hold the notes for seven years and get nothing. But at least your principal is protected at the end.”

Interest rate risk could be a concern over seven years, he said.

“But the good news is that if rates go up, chances are the economy will be stronger and the market will be up too. So you may be able to get to the required step level.

“If it was not fully protected, I wouldn’t like it that much. But with the principal fully protected, I like it,” he said.

Unlikely call

It was not the opinion of an industry source.

“The step up is not beneficial to investors. It considerably reduces the potential of the product being called,” he said.

“People like to be called. They get their coupon and their money back and they move on to something else.

“In this case if you’re not called, you’re not getting paid. That’s the most likely scenario.”

Less volatility, more risk

The nature of the underlying index, which caps volatility, made the occurrence of an automatic call even less probable, in his view.

“This index limits volatility to a certain cap. This means returns are going to be muted. You’re less likely to be above the call level as a result of this.

“When you cap your vol. to 5%, the performance is going to be very limited.

“Imagine the index is down one year. Then you have to move up to 106% within a year. It becomes harder,” he said.

Muted returns

The index has indeed displayed a muted performance, according to data published by Solactive AG, the index calculation agent.

Launched in December 2013 the GS Momentum Builder Multi-Asset 5S ER index has gained 8.18% so far this year through Nov. 1. It was up 5.29% last year and lost 4.78% in 2015.

In 2013, the best year of the current bull cycle, which saw the S&P 500 index climbing 32%, the volatility control proprietary index only rose 4.13%, based on back tested data.

Goldman Sachs & Co. is the agent.

The notes are guaranteed by Goldman Sachs Group, Inc.

The deal priced on Nov. 10.

The fee is 5.02%.

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