GS Finance’s $8.85 million autocalls on EAFE ETF, Russell carry dispersion risk, advisors say

By Emma Trincal

New York, Oct. 25 – GS Finance Corp.’s $8.85 million of 0% autocallable underlier-linked notes due Oct. 23, 2023 linked to the Russell 2000 index and the iShares MSCI EAFE ETF are a challenge for asset allocators and pose additional market risk to investors. In both cases, one of the problems is the disparity between the two underliers, advisers said.

The notes will be automatically called at par plus a 9% annualized premium if the lesser performing underlier closes at or above its initial level on any semiannual observation date, according to a 424B2 with the Securities and Exchange Commission.

If the lesser performing underlier finishes at or above its initial level, the payout at maturity will be par plus 18%.

If the worst performer falls by up to 20%, the payout will be par. Otherwise, investors will lose 1.25% for each 1% decline of the worst performer beyond 20%.

Creditworthiness, buffer

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, first pointed to the valuable features of the deal.

“I have no problem with Goldman Sachs as the issuer. It’s a strong credit,” he said.

“We like the shorter term of two years. We also like the idea of a fee of less than 1%.

“These three things are positive.”

The fee is 0.2%, according to the prospectus.

Some of the terms were also beneficial, he said.

“In a low interest rate environment, we like the 9% annualized return. We also like the 20% buffer. Both things are attractive,” he said.

Dispersion risk

“Unfortunately, a worst of domestic small-cap and international developed large-cap is not something that we particularly like. The two underlying have a modest correlation. One could easily go right and the other, wrong. This is not a risk we would be willing to take,” he said.

The one-year coefficient of correlation between the two underliers is 0.67.

“With a worst-of, we would be looking for a correlation of 0.85 or higher,” he added.

Richly valued

Another negative was the valuation levels of both underlying assets.

“We have two indices that are very close to their all-time highs. Although there’s a buffer, after 20% you have 1.25 times the extra decline. Over two years, it’s very possible that we will see some setbacks. We may be in another phase of the market cycle,” he said.

The Russell 2000 index is trading 20% above its January high. It has jumped 140% from its low of March 2020 during the Covid-induced sell-off. The index is now only 2% off its 52-week high of last spring.

The EAFE index, which is overweight European stocks, has also appreciated meaningfully. It is only 7% off its all-time high of October 2007. From the low of March 2020, the ETF share price has climbed 155%.

Gearing

“Both underlying are overvalued. You could have either one or both down more than 20%.

“It’s nice to have a buffer and I much prefer a buffer to a barrier. But the gearing is a cause for concern. It gives me pause,” he said.

“The 9% return is attractive. But you lose almost 2% on the dividend of the EAFE.”

The EAFE ETF has a 1.88% dividend yield compared to 0.78% for the Russell 2000 index.

As with any other note, investors are not entitled to receive the dividend payments of the underlier.

“Add to that the low correlations between the two indices and you have a note we would rather keep away from,” he said.

Good basic terms

Carl Kunhardt, wealth advisor at Quest Capital Management, said he had “mixed feelings” about the notes as he liked the structure but was unsure of how to position the product in a diversified portfolio.

“I kind of like the note, at least the basic terms. I have no issue with that,” he said.

“The gearing is fine. You’ve got to pay for the buffer somehow. A lot of people like something for free. But you don’t get anything for free. To me the gearing is a nonissue.

“I like the fact that your return is cumulative. The 9% premium is competitive.

“In a vacuum, there is really nothing about this note that I particularly dislike.”

As a stand-alone investment or even for himself, Kunhardt would be inclined to invest in the product.

Asset allocation

“But as an asset allocator, where do I put this note? It’s just one of those things you kind of throw in there. It’s not an international play. It’s not a small-cap play. It doesn’t belong to my core. It’s also not alternative because it has a high correlation to equity,” he said.

The only reason the note would fit in an alternative investment bucket, he said, would be because of its downside protection.

“But that’s assuming that alternative is a black box where you can throw everything that’s not equity,” he said.

A worst-of note with two or three large-cap indexes would have been a better fit, he said.

“If you give me the S&P and the EAFE, it’s an easier fit. Both are large-cap.”

Another example would be three U.S.-based indexes such as the S&P 500, the Dow Jones industrial average and the Russell 2000. In this case, the three blend into the domestic benchmark category.

“It’s a neat little note. But where do I stick this thing?

“It’s not a U.S. play. It’s not an international play. It’s neither large cap or small cap.

“It doesn’t fit into an asset allocation. That’s the problem,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The notes settled on Friday.

The Cusip number is 40057JUS3.

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