GS Finance’s $1.09 million notes on five funds should show income, not growth, sources say

By Emma Trincal

New York, March 24 – GS Finance Corp.’s $1.09 million of 0% ETF-linked notes due March 14, 2024 tied to the ARK Innovation ETF, the ARK Next Generation Internet ETF, the ARK Autonomous Technology & Robotics ETF, the ARK Genomic Revolution ETF and the ARK Fintech Innovation ETF present too much risk and too many underliers to be offered as a leveraged product, sources said.

Instead, investors would benefit from an autocallable structure as it delivers an income stream and a more predictable outcome, they added.

If the return of each ETF is zero or positive, the payout at maturity will par plus two times the return of the lesser performing ETF, according to a 424B2 filing with the Securities and Exchange Commission.

If the lesser performing ETF falls by up to 40%, the payout will be par. If the lesser performing ETF falls by more than 40%, investors will be fully exposed to the decline of the lesser performing ETF.

Cutting edge

The use of ETFs managed by ARK Investment Management LLC in structured notes is a recent trend that has gained momentum since late last year. The actively managed ETFs target the fastest growing segment of the technology sector, focusing on “disruptive” innovations.

Issuers so far this year have priced about $100 million in 99 offerings, according to Prospect News’ most recent update.

The ARK Innovation ETF is the flagship fund. Its price has increased eightfold since inception in 2014.

ARK Investment identifies companies that it believes are leading and benefiting from cross-sector innovations such as robotics, energy storage, DNA sequencing, artificial intelligence and blockchain technology.

Worst of many

“Some investors who share the excitement for the ARKs link all those products together,” a trader said.

“It’s all about disruptive advancements, the best in innovation whether you’re talking biotech, robotic or Bitcoin. The buzz around ARK makes people believe that those different technologies are interchangeable.”

Such approach would be a mistake.

“You’re still talking about five different ETFs. The correlation risk of five is too much. I wouldn’t do that,” he noted.

“Just because those funds look like they can be married together under the same umbrella doesn’t eliminate the huge risk of having five different underlying in a worst-of.”

Income is better

The terms of the deal were attractive, however.

“Two times is good. The uncapped upside is there because it’s expected for this type of play.

“People who buy those high-performing funds don’t want the cap. They want pure growth,” he said.

But while the need for high returns is understandable, the leveraged note structure failed to give investors the full benefit of those underlying in a worst-of, he noted.

“If you want growth you should probably buy the funds outright,” he said.

“I would much rather have more certainty in my return. If I can achieve a 28% annualized coupon with a reasonable coupon barrier, I would be more comfortable. With an income product, you’re more likely to get paid and the potential of getting called away would be a positive.

“You’re seeing such big drawdowns with these funds. A worst of five can easily give at least one bad return, which would yield to nothing at the end.”

High volatility

A market participant agreed.

“You play the leverage and the worst-of in five different ARK ETFs. That’s a lot of ARK on the table,” he said.

He stressed the volatility of the ARK funds.

“I know people who bought it. You’re in it. Then you’re out of it. It moves a lot. You need the stomach for this,” he said.

The ARK Innovation fund is down 28% from its all-time high of Feb. 16.

That’s another reason to get the exposure via an autocallable product, he noted. At least investors get the protection along with the income stream. Cumulated coupons may provide an additional cushion at maturity, he said.

This market participant was also concerned about the higher than usual number of underliers in the worst-of.

“I’ve got five horses in the game...Five horses!” he said.

“What if four of them are up 20% and the other one goes up 3%? Now I’m getting my leverage on this 3% whereas if I have a coupon, even if one is down, I’m still getting my money back if it’s down less than 40% and I’m getting paid along the way. It’s much better to go for the coupon.”

A broader conclusion

An industry source adopted the same reasoning for any kind of worst-of, regardless of the underliers.

“Using a worst-of in a leveraged note doesn’t make a lot of sense because why would you want to bet on the worst performer if you want to participate in the upside?” this source said.

“Unless you add another feature like an absolute return component, you’re better off using leverage on a single underlying and keep the worst-of for income.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on March 15.

The Cusip number is 40057FRR7.

The fee is 1.175%.

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