GS Finance’s autocall buffered notes on S&P 500 need higher call premium, advisers say

By Emma Trincal

New York, Aug. 17 – GS Finance Corp.’s 0% autocallable buffered index-linked notes linked to the S&P 500 index have a competitive buffer to offer. But for advisers, the upside potential was not worth taking the risk of investing in a toppish stock market.

The tenor of the notes is expected to be between 23 and 27 months, according to an FWP filing with the Securities and Exchange Commission. The exact tenor will be set at pricing.

The notes will be automatically called at par plus a call premium of 4.64% to 5.46% if the index closes at or above its initial level on a call observation date expected to be approximately 12 months after the trade date. The exact call premium and call observation date will be set at pricing.

If the notes are not called and the index return is positive, the payout at maturity will be par plus the index return. Investors will receive par if the index falls by up to 20% and will lose 1.25% for each 1% loss beyond 20%.

Credit, single asset

“The call premium doesn’t sit right with me,” a buysider said.

He pointed to some positive aspects first.

“We don’t have any qualms with Goldman Sachs as the issuer. It’s a very short-term note, let’s say a two-year, so credit exposure is not really an issue,” he said.

“One of the nice things is that you’re not looking at a worst-of. This is a straight S&P deal.

“The buffer is substantial.

“But the premium is awfully low.”

Narrow window

Out of the two possible upside scenarios – either an automatic call after one year or the 100% uncapped participation at maturity – the former was the most likely.

“The chances of the index being up over 12 months are pretty darn good. I’d say, it’s well over 50%. The idea that we would intentionally cap our performance at something as low as 5% doesn’t make a lot of sense,” he said.

He assumed the cap would be set at midpoint of the range, which is approximately 5%.

A look at historical data on the S&P revealed a 10% chance for the index to be up by less than 5% over 12-month rolling periods, he noted.

“That means you only have a 10% probability of outperforming on the upside. This is a teeny tiny window.”

Downside

On the downside, investors benefit from a 20% buffer, which allows them to outperform the index. But the payout was leaning too much toward the protection, he said.

“This is a defensive and almost defensive only structure,” he said.

“Even if you outperform thanks to the buffer, you’re not generating any positive return.

“It’s hard for clients to get excited about beating the index without taking any profit if that’s the only incentive you have for investing in this deal.

“If you’re negative about the market, you should be buying an absolute return note.”

Going longer

On the upside, even the uncapped return at maturity wasn’t attractive enough for this buysider.

“If you don’t get called, you get the index return with no cap but there is no gearing. So, you still underperform the index because you paid the dividend to have that downside protection.”

“The only way I win is if the index is down or up less than 5%. Getting 5% is not particularly impressive. “And if the market is down, all I get is my money back. Technically, that’s a win. But it’s nothing to get excited about.

“I don’t think this is a good trade,” he said.

One way to improve the terms would be to extend the maturity. This buysider was open to this option.

“I’d rather have a longer-term note with a higher call premium and some leverage at maturity,” he said.

This structure may add more time between the call and the maturity date for the index to compound gains if the notes are not called, he added.

“For us, two- to three-year is a short-term note. We’re looking at four, five or even six years.

“We always want uncapped returns with some kind of leverage. It doesn’t have to be a lot of leverage, but we want something there.”

Toppish market

Matt Chancey, financial adviser at Dempsey Lord Smith, LLC, also found the terms disappointing. His main concern was the risk on the downside.

“Getting a small, limited upside with a 20% buffer in a market that’s at all-time highs, that to me is a risk return that seems asymmetrical,” he said.

“There is not enough upside opportunity. The juice is not worth the squeeze.”

Chancey said he assesses the value of a buffer based on current equity market valuations and on the risk-adjusted return of the notes, not on the ongoing buffer size seen in recently priced structured note deals.

“The market at the beginning of Covid last year dropped 35%.

“With all the headlines and all this massive stimulus money, at some point the market will turn and we’ll have to pay for that.

“A 20% buffer is not enough when the market is that overbought. And if you get called, you’re not even participating in this index.

“Definitely not a trade I’d be willing to make.”

Given the rising uncertainty in financial markets and in the world, investors may be well advised not to “jump in” at the first opportunity, he said.

Liquidity and timing

“Giving up your liquidity to get those terms doesn’t seem like a really good idea,” he said.

“People often believe that capital always has to be deployed. But you have to pick the right time to get in.

“I’d want substantially more downside protection and a higher return. With 5%, there is no upside.

“Using a high-dividend index fund seems like a better alternative to me. At least, I can enjoy the benefit of a fully liquid investment.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The Cusip number is 40057J5V4.

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