GS Finance’s PLUS due 2021 tied to Topix index designed for mildly bullish investors

By Emma Trincal

New York, March 12 – GS Finance Corp.’s 0% Performance Leveraged Upside Securities due July 6, 2021 linked to the Topix index offer timely pricing at the beginning of a bear market. But advisers debated the various aspects of the risk-adjusted return due to the capped, leveraged exposure on the upside and lack of any downside protection feature.

If the final index level is greater than the initial index level, the payout at maturity will be par of $10 plus 300% of the index return, subject to a maximum return of 22.4%, according to an FWP filing with the Securities and Exchange Commission.

If the final index level is less than the initial index level, investors will have one-to-one exposure to the index’s decline.

Timing

Steve Doucette, financial adviser at Proctor Financial, looked at the current market valuation first.

“It does look interesting because we just entered a bear market. You’re buying at a very low level. But at the same time, you get into a note with limited upside,” he said.

“You really have to be only moderately bullish. How realistic is it to bet on a limited growth once we recover?”

The Dow Jones industrial average is in a bear market since Wednesday and so is the Japanese equity benchmark used as the underlying for the notes.

The Topix index has dropped 23% since the beginning of last month when coronavirus fears began to spook investors worldwide.

Upside risk

“It’s a timing thing,” said Doucette.

“The leverage is good. But if this bear market takes a little time to run its course, you have no protection on the downside.”

In addition, the gains are capped at 22.4%.

“If we have more control over this coronavirus, if some stimulus program is put in place, you could see a rebound fairly quickly.

“Meanwhile mortgage rates are so low, investors have an opportunity to refinance and the housing market could take off quickly as well.”

Tight range

The 22.4% cap is for the 16-month term of the notes. On an annualized compounded basis, the cap would be 16.4%.

“It’s not a bad return,” he said.

With the three-time leverage multiple, the maximum gain can be achieved if the index rises by only 5.55% a year.

“It’s a small range of potential outperformance,” he said, adding that the upside risk could be a concern given how depressed current valuations are.

“What if Japanese stocks surge a few months from now? You’ve limited your potential gain. Chances are you could make more than 16.5% a year. Much more if we have a rally.”

The other scenario is always possible.

“Who knows how long this bear market is going to last? You’re trying to capture the leverage on the upside but you really are making assumptions on the timing,” he said.

“You have unlimited downside, and you’re capped on the upside.

“Your range for outperforming the index is limited. With the volatility we’re seeing right now, the odds of going either direction outside of that range increase significantly.”

Leverage advantage

Jeff Pietsch, founder of Eastsound Capital Advisors, looked at the pros and cons of buying the notes versus owning a leveraged exchange-traded fund on the Japanese equity market. He concluded that the notes were a better option at this time.

“I like the asymmetry of the leverage you find in the notes. You’re up three-to-one but down only one-to-one,” he said.

“An ETF would give you three times the downside. It’s a lot riskier.

On the other hand, the leveraged ETF has its benefits.

“Some may be tempted to downplay the 3x downside exposure given the extent of the current sell-off,” he said.

“The ETF gives you the liquidity without the counterparty risk, and your return is unlimited.”

One-time exposure

But the downside should never be overlooked, and the new shift into bear market territory requires tight risk control, he said.

“You can’t really assume you’re safe just because of a 20% to 25% drop,” he said.

“The advantage of the note is the one-to-one downside exposure. You can sleep better at night.

“If in 16 months we do have a 10% to 15% decline, three times that decline could wipe out a third or nearly half of your principal.”

“The one-to-one downside even with a cap on the upside is a better opportunity in my view,” he said.

But these views reflected his personal choices, he noted.

“Anyone investing in a structured note should weigh up the benefits and risks of each instrument.

“Having the asymetrical leverage is one of the best benefits of a note.

“But counterparty risk and limited liquidity do matter as well, especially in periods of financial stress.”

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

Goldman Sachs & Co. LLC is the underwriter. Morgan Stanley Wealth Management is acting as dealer.

The notes will price on Friday and settle on March 18.

The Cusip number is 36259H542.

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