GS Finance’s notes on Dow industrials offer absolute return, but barrier is a concern

By Emma Trincal

New York, March 31 – GS Finance Corp.’s 0% leveraged notes due April 29, 2019 linked to the Dow Jones industrial average offer most of what investors may need to navigate a choppy market and get positive returns both on the upside and the downside. The only wildcard, advisers said, is volatility, which may obliterate the downside protection in a bearish scenario.

The notes are guaranteed by Goldman Sachs Group, Inc., according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is positive, the payout at maturity will be par plus 1.5 times the return, subject to a maximum settlement amount between $1,270 and $1,315 per $1,000 of notes. The exact cap will be set at pricing.

If the index falls by up to 20%, the payout will be par plus the absolute value of the return. If the index falls by more than 20%, investors will be fully exposed to the decline.

Straightforward

Steve Doucette, financial adviser with Proctor Financial, said the absolute return component and the cap level were both attractive. But his concern was the barrier.

“It’s pretty straightforward. You can make 10% a year. It’s not a bad return over three years,” he said.

“The absolute return component is huge. The Dow is down 20%, you’re up 20%. That’s 40 points of outperformance.

Barrier

“But you get this amazing return so long as you don’t bust the barrier. If you do, you’re left with nothing. You’re long the index. Not great if we have a bear market.”

Doucette said he tries to pick notes that enable him to outperform the market in both directions, up or down.

“This one looks good. The cap is OK. The only time you lose is if you breach this barrier,” he said.

Such scenario was probable if the market – as Doucette anticipates – turns bearish in the next few years.

“It’s an issue,” he said.

“Once a barrier is breached it’s useless, so you have to look at that. If we’re in a bear market and down 25% or 30%, this note is not going to help.”

Buffer preferred

As an alternative, Doucette said he would substitute the existing barrier for a buffer.

“I don’t know how much I could get on that buffer. I could give up some of the absolute return or give up some of the leverage. I’m not absolutely sure. I know I wouldn’t lower the cap. If it boils down to reducing the leverage and/or narrowing the absolute return corridor to get a buffer, then I may look into it.”

Volatility

Matt Medeiros, president and chief executive of the Institute for Wealth Management, pointed to the benefits of absolute return structures when calling the direction of the market is so difficult.

“The advantage to this note is that volatility will remain with us for some time. Much of the equity should be in large-caps, an area that should see a steady asset flow for a while. But after being in a bull market for quite a few years, we could see a pullback,” he said.

“Absolute return structures can be appealing when the markets are as choppy as they are currently.”

Trading sideways

Medeiros did not object to the tenor.

“Three-year is reasonable. I wouldn’t want to go too much further than that though,” he said.

The maximum return on the upside was also seen as acceptable.

“If somebody is looking for exposure to large-caps while taking advantage of the volatility on the downside with positive returns when the underlier is down, this could be very attractive. With the modest to low return expectations in equities for the next few years I’m not too worried about the cap.”

He showed more caution about the downside.

“The barrier is the only thing you have to pay attention to. You’ll have to watch it very closely to see if it can be breached. That’s the risky part of this deal.”

Goldman Sachs & Co. is the agent.

The notes (Cusip: 40054K7F7) will price April 22 and settle April 29.

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