GS Finance’s $21.49 million leveraged buffered notes on S&P 500 offer defensive short-term bet

By Emma Trincal

New York, Jan. 6 – GS Finance Corp.’s $21.49 million of 0% leveraged buffered index-linked notes due Dec. 27, 2021 tied to the S&P 500 index offer a safer play on the index for investors expecting modest gains given the market’s bullish performance in the year just passed. What may be of concern for some is the relatively short tenor as most analysts predict some volatility ahead of this year’s Elections.

If the index closes above its initial level, the payout at maturity will be par plus 1.25 times the gain, capped at 18.75%, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes flat or falls by up to 15%, investors will receive par. Investors will lose 1% for every 1% decline beyond 15%.

Capping is OK

“It’s truly more of a defensive instrument,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

Investors in the notes give up some of the upside as a result of the cap but get downside protection in exchange.

For cautious investors with modest gain expectations, such tradeoff made sense, he said.

“18.75% on two years is not a high cap. But you’re getting the leverage,” he said.

Investors would reach the cap if the index rose by 7.25% a year. The cap represents 9% a year on a compounded basis.

“We just had the S&P returning 30% in 2019. You have to think...30% in the 10th year of a bull market...it’s got to cool off at some point.

“We had a correction in 2018 and also in 2015. So it’s not like the market was all uphill all the time.

“But coming out of 30%, you have to be realistic. We’re not going to get that type of return for the next couple of years.”

The Elections would possibly bring some volatility. However, Kunhardt said he was “optimistic” for 2020.

“We’re more nervous about what 2021 holds,” he said.

Defensive position

Still, Kunhardt, who is modestly bullish, added that he had “no issue” with the two-year holding period.

“It’s nice however to have the buffer. If being capped at 18% is the cost to pay for it, then that’s the cost.

“Unless you roll the dice by engaging in market timing, you need some kind of protection if you’re going to stay invested.”

Kunhardt, who views himself as an asset allocator and a planner, said he always has an allocation to U.S. large-cap equity.

“It’s part of our portfolio at all times. You’re just taking a portion of your core and putting a safety net under it.”

On the downside, the buffer guarantees that noteholders will outperform the index.

“A 15% buffer is better than zero,” he said.

“If you have a bear market, before you start to worry about this note you’ll have to worry about all your other positions that do not have a safety net.”

“It’s a nice defensive trade.”

Cautious

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked the terms. But he would have preferred a longer duration.

“We have no problem with the issuer. Goldman Sachs is on our approved list. In fact, everybody is at this point,” he said, adding that credit spreads have tightened all across the board for U.S. issuers.

“The fee is in the realm of what we would be comfortable with,” he noted, pointing to the 0.55% amount disclosed in the prospectus.

The terms were relatively attractive, he added, especially the downside protection.

“You get leverage on the upside, which helps cover the loss of the dividends.

“The buffer is good.

“We just had a very good year and we’re in the fourth year of a Presidential cycle.

“A lot of people including myself are a little nervous.

“I don’t have a crystal ball, so it’s nice to say to a client, you’re not going to lose anything if the market is down 15%.”

Long-term tilt

And yet, this adviser would probably not consider the notes.

“There is nothing wrong with a two-year term. But for us, it’s probably not long enough,” he said.

Kalscheur tends to buy notes with longer tenors for a number of reasons. First, the terms tend to be more favorable.

“If you extend this note to a four- or five-year maturity, you’ll be able to push that cap up or even get rid of it altogether,” he said.

Kalscheur also believes the downside risk is lower over longer timeframes.

“You have a better chance of outgrowing a recession if you’re investing in the entire business cycle,” he said.

“Two years may just be enough time to be completely slammed by a recession and not enough to get the market back out of it. I just would get nervous.”

A third factor behind his preference for longer-dated notes is simply the way he manages money for his clients.

“We’ve designed our practice around that long-term philosophy. If you’re investing for the long term, you might as well buy long-term.

“The two-year term is not right or wrong. It just doesn’t really fit what I’m trying to preach to my clients,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes (Cusip: 40056XWL6) settled on Jan. 6.

© 2015 Prospect News.
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