GS Finance’s digitals on Nasdaq-100 show potential to outperform on both sides, advisers say

By Emma Trincal

New York, Jan. 18 – GS Finance Corp.’s 0% digital index-linked notes due Feb. 24, 2023 linked to the Nasdaq-100 index offer investors a chance to beat the index in both an up and down market, advisers said.

If the index finishes at or above its initial price, the payout at maturity will be par plus 14.25%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes negative but at or above its 80% barrier level, the payout at maturity will be par Otherwise, investors will lose 1% for every 1% decline from the index’s initial level.

Acceptable cap

Steven Foldes, wealth manager and founder at Evensky & Katz / Foldes Financial Wealth Management, said the product met several of his investment criteria.

“This is an interesting note. The 13-month term is good. We like short-term notes and with 13 months, you get long-term capital gains, which we like as well.

“We also like Goldman Sachs’ credit,” he said.

On the specifics, Foldes was comfortable with the digital payment.

“The fact that you get 14.25% if the index is flat or up is also attractive. 14% is a nice return. I don’t mind the capping because the Nasdaq has already had a nice run,” he said.

Barrier

The 20% barrier offered a “decent” protection although there is more risk involved with the Nasdaq-100 index compared to other benchmarks, such as the S&P 500 index, for instance.

“Having a 20% barrier is still nice.

“As long as the index is not down more than 20% and not up more than 14%, you beat the market. If the Nasdaq rises 4% for instance, you get a handsome result,” he said.

The risky aspect of the investment was on the downside as a barrier breach would cause investors to lose at least 20% up to possibly their entire principal.

“You have a bit more risk compared to the S&P or the Dow since the Nasdaq is more volatile,” he said.

Positive outlook

“But you’re also making a bet on a benchmark that’s positive 75% of the time.

“This is an index that has not dropped drastically since 2008,” he added.

The index plummeted 40.5% in 2008. Since then, it has only posted two negative years, in 2011 first with a decline of less than 2% and in 2018 with a 3.9% drop.

“A 20% decline would be a very severe drawdown for the Nasdaq. Since 2002, you’ve seen a couple of negative years, but the declines were moderate, except of course during the financial crisis,” he said.

Foldes did not rule out the possibility of such a market drop. But the odds for such an outcome were limited in his view.

“It would take a very ugly year to get to that type of drawdown,” he said.

The ability to outperform the index both on the upside and on the downside assuming price moves within a moderate magnitude constituted the main appeal of the product, he said.

“I think they did a nice job.

“They probably had to pick the Nasdaq instead of the S&P to create those terms. If this was done on the S&P assuming the same 80% barrier, the return would have been much lower.

“This is a note worthy of consideration,” he said.

Back-testing proxy

A second financial adviser also expressed interest in the product. But he could not make a firm call on the notes as his investment decisions are based on back-testing data, which he lacked on the Nasdaq-100 index.

“At first glance, it looks like a good offering, but the Nasdaq is one of the benchmarks I have no historical data for. I do have rolling returns for the S&P, the Dow, the Euro Stoxx. But not the Nasdaq. So, I will be a little cautious in my judgment. I’m going to make assumptions based on the S&P, which is not the same as the Nasdaq,” he said.

Looking at 13-month rolling periods of the S&P 500 index over the past 35 years, he found that the index has been negative 26.2% of the time.

“So, your chances of having a positive return are 73.8%. That’s a 26.2% chance of a loss.

“The odds are pretty much in your favor without even talking about the barrier,” he said.

Contained risk

On the downside, the frequency for a negative return within the 20% barrier range was 22.2%. By subtracting this bucket from the 26.2% chance of a negative return, investors are exposed to a 4% chance of breaching the barrier, he explained.

“Four percent. You’re looking at a reasonable risk,” he said.

“But again, these stats are based on the S&P 500. With the Nasdaq, it’s going to be at least 4%, not 4%. How much more? I don’t know. Is it going to be 12%? No idea but it’s likely to be more than 4%.”

“There is some risk there, but it seems pretty contained.”

The barrier size had to be evaluated based on the length of the holding period.

“In 13-month you can only do so much in terms of protection. If you had more protection than 20%, let’s say 25% or 30%, the terms wouldn’t be as good.

“Is 20% the type of protection I would like to have? No. But is it a good protection. Absolutely. This is a good barrier.”

Win, win

On the upside, investors outperform if the index finishes anywhere between 0% and less than 14.25%.

“This bracket for the S&P carries a 34% frequency,” he said.

Any index return from minus 20% to plus 14.25% allows investors to outperform the index, he said.

“Just add these two brackets together, 22.2% for the downside bracket and +34% for the upside and you get with 56.2% a fairly good chance of beating the market,” he said.

Cautious estimate

This adviser pointed to two caveats.

“First, I’m conducting my analysis based on the performance of the S&P 500 index. We know that the Nasdaq is more volatile. So, you can’t entirely rely on the back-testing. That’s one thing,” he said.

The second limitation was the reliability of historical performance.

“We’re entering a more volatile market with rising interest rates, the Fed spending less money and a rampant inflation,” he said.

“It may be a little bit tougher to get high returns this year, in which case, the notes offer a nice boost and a chance to outperform the market.

“On the other hand, if you’re more bullish, if you think this bull market is going to continue at the same pace, you would be better off buying the index itself.”

Favorable

This adviser said he would lean toward the notes rather than an index fund.

“Whenever I can get equity-like returns when taking equity risk, it’s a fair trade. The 14.25% digital meets that definition,” he said.

“I’m capped at 14.25%. I may underperform if we have another big year. But I’m still doing better than bonds.

“I wouldn’t recommend it wholeheartedly simply because I don’t have the right performance data for the Nasdaq.

“But there are a lot of positive things to it – the short-term, the good upside potential, the decent barrier.

“I like it.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes are expected to price on Jan. 21 and settle on Jan. 26.

The Cusip number is 40057KSS3.

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