GS Finance’s bearish autocall absolute return notes on S&P give full protection on short tenor

By Emma Trincal

New York, July 17 – GS Finance Corp.’s 0% bearish autocallable absolute return notes due Jan. 31, 2022 linked to the S&P 500 index offer a somewhat innovative structure. The issuer combined in one deal a bearish bet, automatic call with daily observations, absolute return potential and full principal protection against market risk.

If on any day during the life of the notes the closing level of the index is less than 85% of the initial level, the notes will be automatically called at par plus 4% to 4.25%, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the index return is greater than or equal to zero, the payout will be par.

If the index return is less than zero but greater than or equal to negative 15%, the payout will be par plus the absolute value of the index return.

If the index return is less than negative 15%, the payout will be par plus 4% to 4.25%.

For simplicity, sources used a hypothetical return of 4% in their comments.

The purpose of a bear

“It’s interesting. People are increasingly asking about bearish notes,” a market participant said.

“That’s somewhat unique. I guess you always have to ask yourself: am I using a bear note to hedge or is it a directional bet? This one I think is more of a directional bet.”

His reasoning was that investors seeking to hedge their equity portfolio would be better off buying a put.

“If the market is down a lot, you’re far better off being long a put. Structured notes are not good trading vehicles. If you have a big market drop, it’s not going to be reflected in the bearish note while you would see the value of your put increase right away,” he said.

Imperfect hedge

With the S&P 500 index hitting a new record high last week, investors are getting anxious to find securities inversely correlated to the market.

“People call us to find ways to hedge their portfolios. The advantage of this one is that you don’t have any principal at risk. The limitation is that as a hedge on an equity holding, it’s only a partial hedge.”

For instance, if the market dropped 20%, the note would be automatically called providing investors with a 4% return. But the remaining 16% long position would remain unhedged.

“This note is not to hedge a portfolio. It’s to express a view. If you’re right and the market goes down anytime, you get knocked out with 4% in gain.”

Daily call

The notes get automatically called on any observation date if the index falls by more than 15%. The interesting characteristic of this autocall is its daily observation, he noted.

By the same token, the daily observation considerably reduced the chances of holding the notes until maturity, which in turn, explains why the issuer was able to price the full principal-protection over a tenor as short as two-and-a-half years.

“You are so likely to get knocked out because the call is observed daily that the 100% principal protection is fairly cheap,” he said.

4%, not 15%

The market risk being taken care of, another one emerges, which is a limited potential for positive return, he said.

“You are probably going to get 4% and that’s all,” he said.

“The only way to get more is if you never knock out but at maturity, the index falls above the 85% threshold. What are the odds? It’s threading the needle.”

The range of decline to be able to beat the fixed return would have to be between minus 4% and minus 15% at maturity.

It’s in that range that investors get access to the absolute return, but such gain would have to exceed the 4% contingent return.

The best among those scenarios above the 85% barrier is a 15% drop at maturity, which is not a likely outcome, he said.

“You’ll never get more than 15% and the odds of getting more than 4% are pretty low,” he said.

Fair deal

An industry source said that the deal was still attractive.

“It sounds OK. To begin with I haven’t seen autocalls that can be observed daily,” he said.

“It’s an interesting bond. Look, there’s always a tradeoff. You’re getting your money back at maturity. You may only get 4% but you may get more. Even if it’s only 4%, it’s not so bad compared to Treasuries. It’s a fair bet.”

The notes will be guaranteed by Goldman Sachs Group, Inc.

The underwriter is Goldman Sachs & Co. LLC.

The notes will price on July 26.

The Cusip number is 40056FUP8.

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