Goldman’s 16.8% contingent coupon autocalls tied to three tech stocks raise fears amid sell-off

By Emma Trincal

New York, Oct. 11 – No one will dispute that volatility can push up yields to tempting levels. The consensus is whether it is worth taking the risk for it, according to financial advisers.

GS Finance Corp.’s autocallable contingent coupon notes due Oct. 18, 2022 linked to the least performing of the common stocks of Amazon.com, Inc., Nvidia Corp. and Apple Inc. offer nearly 17% in potential return, an attractive gain compared to a nearly flat U.S. market.

Since the market rout that began last week, the S&P 500 index, which three weeks ago was up 9% for the year, is now only showing a 1.2% gain.

The notes will pay a contingent monthly coupon at an annual rate of 16.8% if each underlying stock closes at or above its 65% coupon barrier on the observation date for that month, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if each stock closes at or above its initial level on any review date after six months.

The payout at maturity will be par unless any stock finishes below its 60% trigger level, in which case investors will be fully exposed to any losses of the worst performing stock.

Company risk

Steve Doucette, financial adviser with Proctor Financial, pointed to the risks.

“16.8% is obviously a very desirable return. But you’re taking a risk with it,” he said.

“First, if I get into individual stocks, I’m exposed to that company risk, which I don’t particularly like. It’s hard for me not to worry.

“But you’re also talking about three stocks that have been going through the roof and that can fall just as easily. Just look at their loss in the past five days.”

Stock market wreckage

The share price of Nvidia dropped more than 5% in the past five days to close at $253 on Thursday. Apple fell 6% to $214 per share and Amazon shed 11% during the same time to $1,719.

“You’re capped at the coupon level but you can breach the barrier. Who knows where these things are going to go,” he said.

“You could be holding these notes collecting no coupon for a while.”

This is precisely the risk if the market is at the early stages of a bear cycle, he noted.

The pullback which began earlier this month remains a wildcard. Over the past couple of days, the sell-off has intensified. The Dow Jones industrial average shed more than 800 points on Tuesday followed by 546 points on Thursday.

Now what?

“No one really knows what prompted this sell-off. I don’t even know what people are predicting. Many attribute the pullback to higher rates. Funny thing is: we should see the opposite happen. People should be buying treasuries in a classic flight to quality. But they’re not doing that. So it’s very strange.

“If people did what the market is worried about, if they were selling out of stocks to rotate into treasuries, yields should be going down, not up. This big shift into bonds, people are not making it yet. So what are they doing with their money? Not sure. For now they’re selling stocks.”

The exact causes of the pullback are still unclear, he concluded. Technical factors, overvaluations in some sectors of the market, especially in large-cap technology, rising interest rates along with inflation fears or simply trade tensions and signs of slowing global growth, all those reasons are valid but the future is hard to predict, he said.

Big movers

“What we know for sure is that you don’t want to own those super volatile stocks if the market plunges. They would be the ones getting hit the hardest given their crazy growth in the last few years.”

In the past four years, Amazon has seen its stock price rise by 461%. Apple has gained 130% since Oct. 2014 while Nvidia has seen its stock price increase 15 times.

“That’s a heck of a lot of growth. It’s hard to get excited even with the 16.8% coupon,” he said.

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, shared some of those concerns in light of the recent sell-off, which has significantly punished the technology sector.

“All three securities had very nice runs over the last four years and with the current pressure on tech and the fact that we haven’t had a prolonged correction in a number of years, I would be concerned just because of the volatility of those underliers as well as the predictability of the income,” he said.

Not only the contingency of the coupon made the payout more difficult to assess, the automatic call meant that investors did not know how long they would be holding the notes.

“In general, I tend to look at things longer term. But nothing here tells you you’ll be holding the notes for four years.

“If it gets called chances are you’ll get paid for six months.

“But it doesn’t appeal to me. There are too many moving parts when I look at these notes,” he said.

Hard to allocate

Independently of current market conditions, the underlying stocks were too volatile to begin with.

“I like to have a better handle on the underlying risk of the investment. With these securities, I’m not sure how to budget the investment for its return characteristics,” he said.

For this adviser, the notes present a hybrid profile, making them difficult to position in a portfolio.

The coupon despite its conditionality is paid monthly. The barrier offers some protection albeit a limited one compared to a bond. These characteristics did not meet the criteria of a bond allocation however.

“Do you look at this for its coupon characteristics and put it in the income bucket?

“Or do you see it as equity given the volatility of the stocks and the type of risk you’re taking?

“It’s neither one nor the other. I just find these securities hard to allocate in a portfolio,” he said.

The guarantor is Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes are expected to settle on Oct. 18.

The Cusip number is 40056EAU2.

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