GS Finance’s $97.03 million digital notes on S&P may not show enough protection, advisers say

By Emma Trincal

New York, Aug. 11 – GS Finance Corp.’s $97.03 million of 0% digital index-linked notes due Aug. 7, 2025 linked to the S&P 500 index drew a heavy bid, which may have originated from a reverse inquiry, an adviser speculated. But the downside protection may be too thin, he and two other advisers noted, especially when notes are used to hedge a portion of the equity bucket in the portfolio.

If the index finishes at or above its threshold level, 90% of initial level, the payout at maturity will be par plus 19.72%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1.1111% for every 1% that the index declines below 10%.

High entry

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was uneasy about investors’ exposure to market risk.

“I do like the digital component to it. It’s an attractive digital coupon,” he said.

“What makes me a little nervous is the tenor of the note.

“This deal is being priced at a multiyear high. There is potential for a pullback at those levels, and I think we could see a drop greater than 10%,” he said.

The S&P 500 index closed at 4,501.89 when the note priced. This initial level set the buffer threshold at 4,051.70, a point last seen at the end of March.

“This security was probably designed for a specific client or situation. Given the size, it could have been an institution. It’s just a guess,” he said.

The trouble with the note was not limited to the short tenor and the buffer size, he said. The type of buffer was also a disadvantage.

“I’m not really a fan of geared buffers. I prefer straight buffers because they give you a clear idea of the outcome.

“If we have a severe downturn, the compounding of the losses could be a real issue. I like to have outcomes that are a little bit more predictable than this.”

On the positive side, Medeiros, who generally does not like caps, did not object to this one.

“I’m not concerned about the cap. I see this note as an income product, perhaps as an alternative to high-yield, not something designed to enhance my return.”

Position in the portfolio

A buysider was not totally satisfied with the buffer either.

“If the S&P is down 10% you can get almost 20%. You really beat the market by a significant amount,” he said.

“But it only works if the market moves sideways. And what if it doesn’t? A 10% decline can quickly happen on a two-year period,” he said.

The lack of participation in the upside may be problematic for asset allocators.

“My problem with that note is how does it fit in a diversified portfolio? How does it find its place in an asset allocation plan?

“I guess you could see it as a little hedge on your equity bucket. You get that 10% buffer.”

He then looked at the upside.

“You’re trying to get a 10% return. Who’s going to complain about a 10% return a year?”

Still. This adviser was not clear about the embedded investment theme of the product.

“I have a hard time figuring out who would buy it even though the deal was obviously a huge success. What’s your view on the market? Range-bound? Well, you have to rule out volatility. I’m not sure it’s very realistic.

“There are opportunities in that note. You can absolutely outperform. But it depends on how and how much the market moves and no one knows that.”

At least, the note offered a “nice way” to lock in a 10% return.

“But I can’t wrap my head around this.

“If you want to use it as a hedge you can do better than that. We design hedges in other ways.”

For this buysider, the 10% buffer was just not big enough.

“You could have a straight barrier with a bigger protection size. You could also add some leverage on the upside. A plain-vanilla leveraged note would make it easier to allocate in the portfolio.”

Deeper protection

The risk-adjusted return of the notes was not attractive, according to another financial adviser.

“I do like the in-the-money digitals. We do it over 13-months to get the long-term capital gains.”

The term “in-the-money” in this case means that the digital trigger is situated below the initial price.

“But to me, a 19.72% digital return doesn’t compensate you for the risk. You can easily finish down more than 10% over two years.”

This adviser said he would also rather have a barrier than the existing small buffer.

He gave the example of a deal he bought earlier this month.

It was a BNP Paribas four-year note linked to the S&P 500 index with an 80% barrier on the downside including a dual directional component. On the upside, the payout was two-times the index’ gain up to 55%.

“We figured, the S&P only needs to be up a little bit more than 6% a year and we get the maximum return.”

On a percentage basis, the 80% barrier doubled the amount of protection.

“If the 10% buffer didn’t have the downside leverage, it may have been a little different. But it’s a geared buffer and we’re not crazy about these. If the index goes down a lot, it could go out of hand.”

He concluded that the risk-adjusted return of the note was not appealing.

“There are other alternatives out there with less risk and a better potential return,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on Thursday.

The Cusip number is 40057TQ72.

The fee is 1.1%.

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