GS Finance’s $5.58 million of notes on S&P offer one-time call, full principal protection

By Emma Trincal

New York, Aug. 18 – GS Finance Corp.’s $5.58 million of 0% autocallable market-linked notes due Aug. 17, 2027 linked to the S&P 500 index are using an increasingly common feature – a one-time autocall – to offer full protection at maturity.

The notes will be automatically called at par plus a 13.55% call premium if the index closes at or above its initial level on Aug. 12, 2024, according to a 424B2 with the Securities and Exchange Commission.

If the final index level is greater than the initial index level, the payout at maturity will be par plus the index gain.

If the index finishes flat or declines, investors will receive par.

Bearish version

GS Finance is using an increasingly popular template in which a one-time automatic call is introduced between the trade and maturity dates, usually after one year. Upon the call, investors receive a premium. At maturity, the currently popular version of this product offers uncapped leveraged exposure with a barrier, according to data compiled by Prospect News.

The recently priced GS Finance note reflects a more defensive version on this structure substituting the upside leverage for the full downside protection. One caveat: the observation for the call is at the end of the second, not the first year; and secondly, the call premium is substantially lower than the “bullish” version of this product type, all things being equal, including the tenor, according to the data.

Unneeded protection

Steve Doucette, financial adviser at Proctor Financial, pointed to the conservative nature of the payout.

“Obviously, you have to be pretty bearish or expect the market to be pretty flat,” he said.

“If you go to maturity you’re not going to outperform. The only advantage is the principal-protection. But am I going to need 100% protection five years from now when chances are we should be up? “We’re partially through a bear market. The big question is how long can it last? On average it’s less than two years and you’re holding the notes for five.

The average length of a bear market for the S&P 500 index is 18.6 months since September 1929, according to S&P Dow Jones Indices.

Doucette reasoned that even if the market was to decline further as it did in the first half of the year, the length of the notes should allow for some recovery time.

“Who needs 100% protection on a five-year? It’s silly. Why would you tie your money for such a long time if you have no leverage at maturity or any kind of return enhancement? You’re only getting the market return. Then why not just buy the index?”

Beefing up the returns

Doucette said he would reduce the protection in order to obtain some leverage.

“That way I can at least outperform the market on the upside,” he said.

In general, this adviser was not very keen on buying fully protected notes.

“You’re giving up a lot for a protection you may not need. I know it’s a great sales pitch to be able to say: you won’t lose money; your principal is guaranteed unless the bank goes belly up. For people who got burned once and don’t want to go back to the market, the 100% principal protection is a great sale,” he said.

But for Doucette, the cost of the protection was too high.

“You don’t really get much of anything for tying up your money for five years,” he said.

Another disadvantage of those products was the tax treatment.

“You have to pay ordinary income taxes on a zero coupon. Investors do not receive interest, but they still have to pay taxes on the income every year. They call it phantom income. Who wants to do that?” he said.

Premium, secondary market

A very moderately bullish investor may find the call premium attractive. But Doucette didn’t hold such a view.

“To make this call return worth anything, you have to believe that the S&P isn’t going anywhere. It’s not going to be up more than 13% in two years. So, you’re trying to outperform the market by getting 6.5% a year? Really?”

Meanwhile investors are taking a chance to be long-term holders of the notes.

“If you don’t get called, you’re just long the index,” he said. “If you don’t want to keep the paper until maturity, if you want to sell it to the issuer, you’ll get less than the S&P return because you never get the full value. The issuer’s bid will always have a spread, at least a 1% spread to get out of there.”

Core portfolio

Matt Medeiros, president and chief executive of the Institute for Wealth Management, saw the notes as a good tool for an asset allocator.

“I really like this one. This is a good product for a client or adviser building an asset allocation strategy,” he said. “The S&P 500 is the basis of your core holdings in a diversified portfolio. With its five-year term and full downside protection, this is going to let you sleep at night. You can hold it for the long haul. You don’t have to worry about your position.”

Medeiros was not too concerned about the size of the call premium given his own market outlook.

Positive scenarios

“The return offered if you get called is slightly lower than the return of the S&P from a historical perspective. But it is in line with my own expectations of mid-to-low-single-digits,” he said.

“It’s not a very optimistic view. But it’s my short-term view.

“Over a five-year period, I’m much more optimistic. But I’m also cautiously optimistic and that’s when the principal-protection adds a lot of value.”

Just because the note offered no leverage did not mean investors were penalized on the upside.

“If you’re held to maturity, you have no cap on the upside. This is huge.

“Having full participation in the gains, no cap and full downside protection, these are the characteristics of a very attractive equity replacement in your portfolio,” he said.

He compared the note to an “insurance policy” except for the credit risk exposure.

“If it’s flat or up in two years, you’ll make money.

“If you hold it to maturity, you’ll make money if the market is up; you won’t lose money if it’s down.”

Simplicity

The notes also allowed advisers to better manage their clients’ expectations.

“If after five years the index is negative and you’re getting your money back, the note would have done exactly what it was expected to do. The client will be OK because the note met their expectations.

“It’s a straightforward, easy to understand product. I like it for its simplicity, and I like it for the protection.”

The securities are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent with UBS Financial Services, Inc. as selling agent.

The notes settled on Wednesday.

The Cusip number is 40057MUK3.

The fee is 2.5%.

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