GS Finance’s notes tied to technology ETF show modest leverage, long tenor, buysiders say

By Emma Trincal

New York, July 23 – GS Finance Corp.’s 0% leveraged notes due Aug. 3, 2023 linked to the Technology Select Sector SPDR fund may appeal to bulls due to an uncapped return and leveraged upside. However, the leverage multiple was seen as weak given the relatively long holding period, advisers said. In addition, the downside protection may not be sufficient in a recession scenario given the volatility of the sector, they added.

If the ETF return is positive, the payout at maturity will be par plus 1.06 times the ETF return, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF declines but by no more than 30%, the payout will be par. Otherwise, investors will lose 1% for every 1% decline of the ETF from its initial level.

Disappointing trade-off

“The protection isn’t worth what you’re giving up,” said Jonathan Tiemann, president of Tiemann Investment Advisors.

“The upside you’re getting isn’t really compensating you for giving up the liquidity over four years and foregoing the dividends over a relatively long period of time.”

The Technology Select Sector SPDR exchange-traded fund yields 1.25%. Over the four-year tenor, investors would have to forgo approximately 5% compared to the fund’s shareholders, who get the total return. Investing directly in the fund provides a 5% cushion, a much smaller amount of protection than 30% but one that operates as a buffer, he noted.

“Obviously the loss of dividends is what people pay for the 30% protection on the downside,” he said.

“But given the liquidity issue over a period of four years, I’m not sure it’s a good trade.”

One of this adviser’s main objections to structured products in general is the relatively limited liquidity of those instruments designed primarily for buy-and-hold strategies.

“No assurance can be given as to the liquidity or trading market for the notes,” states the prospectus.

Credit risk

The issuer’s creditworthiness is also not among the best among U.S. banks, he noted. The five-year credit default swap spreads are 58 basis points compared to 40 bps for Wells Fargo and Bank of America and 35 bps for JPMorgan.

“It’s not really a big red flag given how tight the spreads are for U.S. banks. However, credit risk is always part of what you have to think about,” Tiemann said.

The notes offered very little appeal on the upside due to the small leverage multiple. The main benefit was the preservation of the principal up to a 30% drop in the ETF price, he noted.

“But it’s still a barrier, not a buffer. Sure you’re better off with the notes if the fund declines between 5% and 30%. But four years from now this tech fund can easily drop more than 30%.

“That’s why losing the dividends and giving up the liquidity is not worth what you’re getting, which is a bit of upside leverage and a barrier that can be knocked out fairly easily given the underlying’s volatility,” he said.

Recession factor

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, pointed to the long tenor as a main drawback.

“In general, the tech sector, if we have a recession, could be hit hard because of the elevated valuations,” he said.

“If the ETF keeps growing, it’s an interesting way to play a bullish view since there isn’t any cap and some leverage.

“But the challenge is really going to be on the downside. It’s far from certain that 30% is going to be enough.”

Chisholm said he would have liked a deal with a one-year tenor and a buffer instead of a barrier.

“I’ve seen deals like that on a one-year. But for a four-year, it’s a long time to tie your money up,” he said.

Too long

The “risk” could be on the upside as well.

“If the tech sector continues to rally, if it goes up 50% in the next two years and then falls, you won’t be able to lock in your gains from the first half of the term,” he said.

“The structure is OK. But the term is too long.”

The notes are guaranteed by the Goldman Sachs Group, Inc.

Goldman Sachs & Co. is the agent.

The notes will price on July 30.

The Cusip is 40056FVB8.

© 2015 Prospect News.
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