GS Finance’s $2.85 million leveraged notes on S&P 500 Value offer timely defensive strategy

By Emma Trincal

New York, Jan. 28 – GS Finance Corp.’s $2.85 million of 0% leveraged index-linked notes due Jan. 23, 2026 tied to the S&P 500 Value index may appeal to investors as a less risky investment amid the heightened volatility in the market seen in this new year, said Clemens Kownatzki, finance professor at Pepperdine University.

If the index return is positive, the payout at maturity will be par plus 1.121 times the index return, according to a 424B2 filing with the Securities and Exchange Commission.

If the index is flat or declines by up to 20%, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the index from its initial level.

2020 bull market

“As tech shares are in freefall, getting exposure to less risky assets seems like a reasonable proposal,” said Kownatzki.

The rotation from growth to value has been a continued theme on Wall Street as growth stocks have reached extended valuations.

Even the S&P 500 index itself is overweight growth with five stocks – Apple Inc., Microsoft Corp., Amazon.com Inc., Alphabet Inc. and Meta Platforms Inc. – making for more than 22% of the index.

“For a long time, value underperformed growth. After the Covid pandemic erupted leading to the severe but brief drawdown in 2020, growth stocks, especially in the tech sector, suffered the most severe losses,” said Kownatzki.

But the downturn of February-March 2020 rapidly shifted into a roaring bull market.

“Growth stocks had a very robust recovery; value shares on the other hand were lagging,” he said.

Value is back

Since the start of the year however, a reversal has taken place with value regaining popularity.

“We’re now seeing value stocks outperforming growth as technology shares have been under heavy selling pressure,” he said.

The Nasdaq has already entered correction territory, down 12% this year.

“In comparison, value stocks are holding up much better,” he said.

The performance gap between value and growth is tightening this year. The S&P 500 Value index dropped 4% year to date, outperforming the S&P 500 index and the S&P 500 Growth, which are down 7.7% and 11.7%, respectively.

Flight to quality

“The S&P 500 Value index is a safer place to be in. These are banks, energy, health care companies with less expensive stocks and smaller growth prospects. But they hold up well during bear markets,” he said.

“It’s a well-diversified benchmark. Many of the constituents are high dividend paying stocks.”

Berkshire Hathaway Inc., Johnson & Johnson, Procter & Gamble Co., Exxon Mobil Corp. and Chevron Corp. are the top five holdings.

“Now that we’re in correction mode, people are going to look for value stocks to reduce volatility in their portfolios. During turbulent times, investors move from risky assets to places that are a little bit safer like fixed-income, high-paying dividend-stocks and value,” he said.

The S&P 500 Value index yields 1.80% versus 0.45% for the S&P 500 Growth index.

“The note can be used as a defensive play if you’re concerned about the risk of a market downturn,” he said.

No cap, term

Kownatzki pointed to other terms in the structure, which he liked as well.

“The no-cap on a four-year tenor is attractive,” he said.

“The leverage isn’t huge. But a 1.12 multiple more than compensates the loss of dividends.”

“There is an argument to be made for a little bit more leverage maybe when you’re investing in something that performs at a slower pace.”

But the prevailing strength of the notes was defensive, not bullish, he added.

“You’re not betting on skyrocketing gains. You’re looking for an alternative to risky assets in a volatile, uncertain environment.

“You’re getting the exposure to an alternative asset class with growth potential and downside protection.

“It’s not a bad note,” he said.

Downside protection

Kownatzki said he was comfortable with the barrier size because the four-year period allowed enough time for a recovery.

“No one can really forecast the market four years from now,” he said.

“But the longer duration and the lower risk associated with the asset class suggest that the 80% barrier is reasonable.”

Market shift

If a rotation into value really takes hold over the next few years, investors could outperform the overall market despite the low leverage, he added.

“We’re not going to get 25% a year in the next couple of years. Most strategists anticipate more modest gains.

“As more people share the same expectation, demand for value stocks may increase and this index may go up. It’s a self-reinforcement cycle.

“We’ve been so spoiled by these double digit returns for many years now. If you can tame investors’ expectations – and this note certainly does that – it’s the right approach.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The notes settled on Jan. 25.

The Cusip number is 40057KTH6.

The fee is 2%.

© 2015 Prospect News.
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