GS’s $87.35 million digital notes linked to S&P 500 seen as coming out at right timing

By Emma Trincal

New York, May 4 – GS Finance Corp.’s $87.35 million of 0% digital index-linked notes due Aug. 4, 2021 tied to the S&P 500 index priced at a time when the market was still off its high, which brings a margin of safety, advisers said. The downside payout adds to the appeal for investors who are not overly bullish, they noted.

If the index return is greater than or equal to negative 10%, the payout will be par plus 13.9%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is less than negative 10%, investors will lose 1.1111% for every 1% index decline beyond 10%.

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes would fit a neutral market outlook.

“I might do it although I’m not sure,” he said.

One shortcoming was the leverage applied to the buffer.

“I don’t particularly like geared buffers because they’re hard to explain,” he said.

“With a straight buffer you can show the client how it works very easily with a simple graph.

“When you start getting into leveraged buffers it’s not an easy conversation anymore. Clients don’t like the idea of leveraging the downside.”

Cap issue

At first, the 13.9% digital return over 15 months appeared attractive, he said, especially with the digital payout set to strike 10% below initial price.

“But coming out of a market like this, the cap may come into play.”

Whether the cap will be perceived as a penalty by investors naturally depends on their market outlook.

The timing of the pricing, which occurred on April 28 with the S&P 500 index at 2,863.39, was an especially important aspect of the deal.

Higher yet lower

“The return is all predicated on the day of pricing,” he said.

“The note resets the index on day one of the deal and we’re already down double-digits from both the beginning of the year and from the February peak.”

On the trade date, the underlying index was 31% higher than its 2,191.86 low of March 23. Yet it remained 16% lower than its all-time high posted on Feb. 19, which was 3,393.52.

The S&P 500 index on the trade date was also down 12% for the year.

“We’re up from the bottom but we still haven’t recovered totally from the highs,” he said.

For moderate bulls

“If you really think the market is going to have pretty limited gains, that note might make sense.

“But you have to have the conviction that it’s going to be in the single-digits.

“I’m not in that camp,” he said.

He added that it is a difficult time to be in one “camp” or another given how uncertain the future is amid the coronavirus crisis and its impact on the economy.

Crystal ball

“We never shut down the economy before. We’ve never done it in history. None of the fundamental analysis makes any sense right now. We have to rely on technical analysis.”

Given that the market is still down from its high and for the year, focusing on the upside was a start.

“We tend to look at the calendar year and we’re already 16% in the hole for the calendar year.

“I’m not sure we have a huge downside risk exposure.

“If you’re going to use this note as a hedge, there are better notes. You could get a more generous buffer or barrier or an absolute return.

“I think the real issue here is the cap,” he said.

Big deal

Michael Kalscheur, financial adviser at Castle Wealth Advisors, was enthusiastic about the deal.

“The size is a testament to the timing and the terms,” he said.

“We’re comfortable with Goldman Sachs’ credit. The 63-basis points fee per annum is great.

“We like the S&P 500. You can’t find more plain vanilla than this.”

Tax benefits

Kalscheur usually looks for longer-dated notes and he considers 15-month as short-term. But since investors hold the notes for more than a year, they can benefit from the preferential long-term capital gains tax treatment, he said.

Kalscheur did not mind the geared buffer. In fact, he liked it for tax purposes.

“I love geared buffers for taxable accounts,” he said.

“In theory, you can lose 100% of your principal. That’s a plus from a tax standpoint. I could ask any CPA and they would tell me that you’re not going to be subject to ordinary income taxes. Your losses will be treated as long-term capital losses.”

This tax consideration was important in his practice.

“We don’t have one structured note for an IRA, one structured note for a taxable account. You only have one structured note. The geared buffer simplifies the taxes,” he said.

Timing

The 13.9% digital payout, or approximately 11% per year, was “not too bad,” he said.

“We like to see double-digit returns, so this is fine.

“But what we really like a lot is the timing of this.

“If that note had priced on April 1, I would have said: ‘No. I don’t want to cap my upside.’ A month ago, six weeks ago, I wouldn’t even have looked at it.

“But now that we’re off the bottom and that we had this huge recovery, it’s absolutely perfect timing,” he said.

Suitability

The notes would not be suitable for investors betting on a strong rally over the period. But the upside was still reasonable.

“Fifteen months from now, if the market absolutely takes off, well I have 13.9%. It’s not bad,” he said.

“You just can’t be a roaring bull.

“That’s why you don’t put all your money in it.

“But for that timing you get a really good combination.”

Buffer

If on the other hand, the market finishes negative, investors will outperform the benchmark in different degrees.

Any decline of less than 10% would provide a sizable excess return over the market.

“You could do really well in that range,” he said.

But even if the market falls by more than the buffer amount, noteholders would still outperform the benchmark.

“Let’s say, 15 months from now, we’re still battling Covid-19. The market is way down. Even then I’ll beat the S&P. I’m still cushioned. Even if it’s a geared buffer, it’s still a buffer and it’s a good buffer,” he said.

Beats the absolute

Compared to an absolute return, Kalscheur said the digital payout with a strike at minus 10% was more impressive.

“I’m not always comfortable with absolute return notes. Not that it’s a gimmick. But I don’t really like the risk-reward,” he said.

He took the example of an absolute return note with an 80% barrier.

“What you really want is to maximize your return. You maximize your return when you’re down 19.9%, when it’s dangerously close to the barrier.

“That’s not the right risk-adjusted return. It makes a big difference whether I’m down 1% or 19%.”

In comparison, this digital note was more straightforward, he said.

“Whether you’re down 1% of 19%, you know exactly what you’re getting.

Overall, Kalscheur was very impressed by the offering.

“I like it. I like the terms.

“But most of all, I like the timing.

“I could see that being a very good fit for most clients, especially the most conservative ones,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes will settle on Tuesday.

The Cusip is 40057E4E4.

The fee is 0.79%

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