GS Finance’s barrier notes with daily observation on S&P give full protection, absolute return

By Emma Trincal

New York, Sept. 27 – GS Finance Corp.’s 0% barrier absolute return market-linked notes with daily barrier observation due Jan. 4, 2024 linked to the S&P 500 index give investors full principal protection at maturity plus a minimum 1% bonus. Investors also have the potential to participate in the absolute return of the index up to a cap making the note a good fit for risk-averse investors, advisers said.

The type of payout at maturity will be determined by the occurrence of a barrier event during the life of the notes.

Such “event” will occur if, on any day during the life of the notes, the index closes below or above its initial level by more than 26.7%, according to a 424B2 filing with the Securities and Exchange Commission.

If a barrier event has occurred, the payout at maturity will be par plus 1%.

If a barrier event has not occurred, the payout at maturity will be zero or positive and will equal the absolute value of the index return.

Bearish tilt

“If you’re up 100% anytime, you’ll make 1%. If you’re down 100% anytime, you’ll make 1%. But if you stay within that -26.7% +26.7% range, you’ll get the absolute return capped at 26.7%. I think it’s a little bit complex for most people but at the same time, it looks reasonable,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

While the structure features both an upper and a lower barrier, Chisholm said the odds of a barrier breach were greater on the downside.

“Personally, I think there’s a reasonable probability that the market may drop an additional 40% to 60% from where we are. I don’t know if it’s going to happen in the next 15 months or the next two years...probably more in the in next two years. So, to me, principal protection is very important,” he said.

Absolute return

The downside risk was fully covered, he noted.

“If you breach one of the barriers, you’re most likely to be down more than 26.7%. And if the wheel falls off the bus, you’ll be protected.”

The absolute return component allowed investors to participate regardless of the market direction.

“If the index stays within that range either up or down, you can catch a return of up to 26.7%. On a 15-month, it’s pretty decent,” he said.

No real opportunity cost

The only “risk” associated with the note would be on the upside. Even if the index ended up significantly higher, a breach of any of the barriers during the life of the note would cut investors’ gains to 1% at maturity.

“In theory the market could be up in 15 months. Some people may choose to look at the 1% return as an opportunity cost if the market rallies significantly, but that’s the condition for the protection,” he said.

“Current Treasury yields by far exceed that 1% return so one may think of this as another type of opportunity cost. But with this note, you have upside potential of up to 26.7%, which you don’t have with Treasuries.

“You can’t lose money in a down market and if the index stays within the range, you could potentially get a decent return.

“I think it’s a good note.”

More maneuvering room

Jonathan Tiemann, president of Tiemann Investment Advisors, said the new interest rates environment has made principal-protection more available to investors, especially for short maturities.

“This is the kind of structure you couldn’t put together for a while but now that interest rates are higher it’s finally possible,” he said.

The difference between the risk-free rate of approximately 4% (the one-year Treasury yields 4.12%) and the 1% bonus can be used to finance the structure, he said.

“The difference is wide enough to be used to pay for the downside protection. Plus, you are selling off the upside since your return is capped at 26.7%. With that, you can also pay for the absolute return on the downside all the way down to the barrier strike,” he said.

“This would not have been possible a year ago when rates were low.

“Higher rates create more maneuvering room, more value with which to pay for structures like this.”

The note’s main benefit was to remove market risk exposure.

“The only thing you have to be concerned about is credit risk. But with Goldman Sachs, I wouldn’t worry about it,” he said.

Short volatility

Tiemann, who does not invest in structured products, said he had a positive opinion on this note.

“It doesn’t seem so bad, especially on such a short tenor. I have not seen many 15-month notes offering full principal protection,” he said.

Investors in the notes are simply betting that the magnitude of the index’s price move will be contained during the entire period, never exceeding 26.7% in absolute value. If the bet proves to be correct, investors will outperform the market on the downside.

“You are selling volatility. That’s part of what’s providing the guarantee,” he said.

“26.7% is a big move on the downside. But in 15 months it definitely could happen. We just started to see big moves. We could see more. How much more depends on the kind of uncertainty we’re going to face.”

Right now, what drives volatility is the Fed raising interest rates in an effort to tame inflation and the ensuing risk of a recession, he added.

100% versus 101%

Typical principal-protected notes offer a return of 100% of principal. This one brings an additional 1% bonus.

The difference was not significant, he said.

“That 1% bonus is just something that improves the optics. It’s a way for the issuer to give you something.”

The cost of including a bonus however may have been a “slightly” narrower range of absolute return, he said.

He gave an example: if the barrier levels had been -30% and +30% instead of -26.7% and +26.7%, the pricing of a 1% bonus may not have been possible.

“With a wider range, you would have less pricing power. A higher barrier is a call you’re selling at a higher strike. That call would be worth less so you would get less from selling the upside.”

But Tiemann did not believe the addition of the 1% bonus would have made a significant difference.

“Could they have priced a 30% barrier instead of 26.7%? I don’t know. My guess is that the 1% is probably there just to give a better look,” he said.

Staying the course

Tiemann said the notes could be used by skittish investors reluctant to invest or hold a position in a down market.

“If you’re a nervous investor willing to sell volatility, the note can motivate you to hold on to your market exposure instead of selling, which you might otherwise feel compelled to do in a declining market.

“I can see how it may help some investors.”

“I sort of like it,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

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

The notes priced on Sept. 26 at an initial and indicative index level of 3,693.23 struck on Sept. 23. The notes will settle on Sept. 29.

The Cusip number is 40057NDQ7.

The fee is 1%.

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