GS Finance’s $3 million capped buffer gears on S&P reflect cautious, rangebound view

By Emma Trincal

New York, Sept. 30 – GS Finance Corp.’s $3 million of 0% capped buffer gears due Nov. 30, 2023 linked to the S&P 500 index could meet some of the requirements of bullish investors if it was not for the cap, advisers said.

The structure, they noted, is best suited for a sideways market than a bullish play following the current market slump.

If the final index level is greater than the initial level, the payout at maturity will be par plus three times the index gain, subject to a 14.65% cap, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or below the initial level but at or above the downside threshold, which is 85% of the initial level, the payout will be par.

If the index finishes below the 85% downside threshold, investors will lose 1% for every 1% index decline beyond 15%.

Fee, credit

“It’s an interesting note. We don’t have a problem with Goldman’s credit but the 2% fee for a 14-month note seems very high,” said Steven Foldes, wealth manager and founder Evensky & Katz / Foldes Financial Wealth Management, commenting on the fee amount disclosed in the prospectus.

Foldes said he likes short-term notes such as this one. But the structure did not match his bullish outlook on the market.

Stock slump

“This is a note for somebody that’s either bearish or just moderately bullish,” he said.

“Having a 15% buffer on a short-term note is very nice. Having three-times leverage on any note is very nice. But it’s a very low cap and you’re buying an asset class that’s already down 25% over the past nine months.”

For Foldes, the decline in the S&P 500 index meant two things: not enough upside potential and an amount of downside protection exceeding what’s necessary.

The 14.65% cap over the 14-month tenor is the equivalent of a maximum annualized return of 12.45% on a compounded basis. Such return can be obtained if the S&P 500 index rises by only 4.17% a year.

Bright outlook

“If you’re not expecting more than 4% a year in the next 14 months, then you probably don’t believe the market could be coming back soon. But we think it’s very possible,” he said.

“Our view of the history of bear markets is that the market can recover in a robust manner. Capping this potential surge might be a big disservice to our clients.”

Foldes explained why he anticipates a recovery sooner than later.

“The current drawdown is driven by the Fed’s tightening. Once the Fed takes its foot off the pedal and stops increasing rates, we expect a strong recovery. Ultimately, the Fed will start easing as opposed to tightening and when this happens, you don’t want to limit your upside,” he said.

Different opinions

Foldes acknowledged that market sentiment is gloomy right now as the indexes are trading at their lowest levels of the year.

After the Fed voted for another 75 basis point rate increase two weeks ago, more investors understood that the Fed will continue to aggressively hike rates to rein in inflation even if it means driving the economy into a recession, analysts said commenting on the pullback.

“People have different views, which is why each structured note is different,” said Foldes.

“Our view of the history of market recoveries is different. For us, 14 months is enough time to go back to a thriving market. By then, investors will have digested that the recession is over or will be short-lived, the big rate hikes will stop, those clouds will dissipate.

“We think we could see a substantial uptick. We wouldn’t want to miss out on a big rally.”

25% discount

While the current bear market can be scary, it also offers better entry prices for investors who should tap into the opportunity of buying the S&P 500 index at a 25% discount, he said. The market decline offers not only an additional margin of safety, it raises the odds of a strong performance once the market recovers, he added.

“That’s why having a cap now is difficult.

“Because we had such a steep decline, we don’t need such a buffer. We need more upside than 14.65%.

“I don’t know if we’ve bottomed down or if the S&P is going to move lower. But we want to allow our clients to participate in the recovery. We have to either eliminate the cap or raise the cap to a substantial level to make this note work for us,” he said.

Rangebound view

Another financial adviser also pointed to the need for a higher cap but adopted a different approach to reach this goal.

“If you buy this, you really think the market is going to be rangebound, between -15% and +15%. With the volatility that we’re encountering, where is the market going to end up in 14 months is anyone’s guess,” he said.

“The 3x leverage is nice. But if it’s up 4% you max up the cap. So, your view actually ranges from -15% to +4%, which is obviously more bearish than bullish.

“Is this the right outlook? If you think we’re heading to a recession, maybe. We do have a lot of potential headwinds and we’re talking about something that’s going to last until the end of next year.

“Is 14-months the right timeframe? That’s the key question, I suppose. If you don’t expect the market to go up more than 4% during that time, then it’s the right note. The 3x leverage will boost your return and you’ll outperform. But if the market goes up more, you get capped out pretty quickly.”

Leverage, tenor

This adviser said he would probably reduce the leverage in order to increase the cap.

“Not that I’m expecting the market to be up. But I would want to hedge the position both ways, and no one knows if the market is going to be up only 4% next year. The hardest thing is to figure out how quickly the S&P may move back up,” he said.

This adviser was comfortable with the protection.

“I do like the buffer. I would leave the buffer where it is. I would just try to get as much cap as I can,” he said.

Another possibility other than diminishing the leverage was to extend the duration of the notes, he said.

“Since the tenor is the hardest thing to figure out, you might as well make the note a little bit longer and see if you can raise the cap that way or even get rid of it. That would be another way to address the cap issue,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent with UBS Financial Services Inc. as selling agent.

The notes settled on Friday.

The Cusip number is 36264Q677.

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