GS Finance’s leveraged notes on S&P 500, Euro Stoxx 50 offer uncapped, buffered exposure

By Emma Trincal

New York, July 28 – GS Finance Corp.’s 0% index-linked notes due Aug. 3, 2023 tied to the S&P 500 index and the Euro Stoxx 50 index provide uncapped leveraged exposure to the worst of two large-cap indexes with no cap on the upside and a buffer on the downside. One of the risks associated with the notes however is the lower correlation between the two underlying indexes as the payout is based on the worst of the two.

If each index finishes at or above its initial level, the payout at maturity will be par plus 130% of the return of the lesser-performing index, according to a 424B2 filing with the Securities and Exchange Commission.

If the lesser performing index falls by no more than 20%, the payout will be par.

Investors will lose 1% for every 1% decline of the lesser performing index beyond 20%.

Downside protection

“This seems to be a really straightforward product. It’s these types of notes that people are looking for in this environment,” said Matt Medeiros, president, and chief executive of the Institute for Wealth Management.

“In the U.S. as well as in Europe, there is a lot of uncertainty.

“So, having a buffer, for sure, is part of the appeal.”

Medeiros said he liked the size of the buffer.

“20% is a particularly good buffer for a three-year note. You probably get this because of the worst-of payout.”

It has been difficult in the current market to find bullish notes with solid downside protection, he added.

“The notes we’ve been looking at have been shorter and with barriers. Some of the ones we’ve seen are autocallables but not all of them. But there wasn’t much of downside protection. Buffers are harder to find,” he said.

No cap

The uncapped leveraged upside exposure was another positive aspect of the structure.

“I don’t like caps in general, so not having one especially for this timeframe is appealing,” he said.

“My view has always been when you take equity risk, you should get equity reward, so I do like the uncapped upside a lot.

Market bet

Growth notes providing participation in the gains allow investors to express directional views.

“Recently autocallables have been very popular and for good reasons. Income notes allow you to hedge and to get a consistent yield.

“This one is more of a bullish product, which is fine.

“If you’re bullish, you don’t want your upside to be capped. But it’s also good to have a buffer like this one.

“I do like this note,” he said.

The anti-diversifier

Jonathan Tiemann, president of Tiemann Investment Advisors, was not favorable to a worst-of exposure between the two asset classes.

“If you think your portfolio is overly diversified, you can fix that with a worst-of,” he said.

“I mean...by taking the worst-of, you can undo all the benefits of diversification.

“I’m being facetious but really that’s what a worst-of is. Diversification is designed to reduce your dispersion risk. And worst-of increase that risk. So, that’s a little bit of a problem.”

Correlation

The choice of the underliers exacerbated his concern.

“People usually allocate to Europe as a way to diversify away from U.S. equity.

“It’s hard to figure out why you would want to do that.”

“I understand it’s a tradeoff. You get the leverage and the buffer. But the worst-of works against the very idea of asset allocation.”

The correlation between the U.S. large-cap index and its European counterpart is lower than that between two U.S. indexes, he noted.

The S&P 500 index and the Euro Stoxx 50 index show a 120-day coefficient of correlation of 0.93.

Between the S&P 500 index and the Dow Jones industrial average, the coefficient is 0.99.

“They’re not entirely uncorrelated. But again, one reason for investing in European stocks is to get this diversification opportunity, which you’re eliminating altogether,” he said.

Liquidity

Investing in the notes requires other concessions, which are common to most structured notes, he added.

“Of course, you sacrifice the liquidity as you always do with those things.

“You should buy it with the intent to hold it to maturity because structured notes are not very liquid even though in principle you can sell them in the secondary market.”

Dividends

The non-payment of dividends had to be taken into account as well in order to compare the notes with a direct investment in one of the two assets, he said.

The Euro Stoxx 50 index is the underlier offering the greater dividend yield at 2.5% versus 1.8% for the S&P 500 index.

“To come up better with these notes than with the total return you would need the price return to rise by about 9.5% a year. It takes a pretty strong market on the upside.”

On the downside, the 20% buffer is effectively protecting against losses beyond the compounded dividend amount over three years, which is approximately 7.7%.

“The terms aren’t’ bad. But there are a lot of things you have to give up.

“I’m not sure I would use it,” he said.

The notes will be guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The notes will price on Wednesday.

The Cusip number is 40057CHK0.

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