Goldman Sachs’ six-year notes linked to S&P 500 aim at beating index in both directions

By Emma Trincal

New York, Dec. 17 – Goldman Sachs Group, Inc.’s 0% notes due Dec. 27, 2021 linked to the S&P 500 index offer investors a minimum positive return with no maximum return along with contingent protection on the downside, according to a 424B2 filing with the Securities and Exchange Commission.

Sources said they like the risk-reward of the notes, citing the long tenor and the loss of dividends as the main drawbacks.

If the index return is zero or positive, the payout at maturity will be the greater of (a) the threshold settlement amount of $1,510 to $1,580 per $1,000 principal amount and (b) par plus the index return, according to the prospectus.

If the index return is negative but not below negative 30%, the payout will be par. Otherwise, investors will be fully exposed to any index decline.

Bank of America often uses a similar structure, its market-linked step-up notes, that offers a minimum return with unlimited upside above it with. But data compiled by Prospect News points to two important differences: the step-up notes are usually much shorter in duration and tend to come without a downside protection feature.

Advisers said the trade-off for the barrier is a longer holding period

Credit

“I do sort of like it,” said Steve Doucette, financial adviser at Proctor Financial.

“For sure, you have more credit risk exposure over six years and you’re exposed to Goldman’s credit.”

Goldman Sachs’ five-year credit default swap spreads are 84 basis points, close to Morgan Stanley’s 85 bps and 3 bps more than Citigroup, according to Markit. But Bank of America and JPMorgan have spreads of 73 bps and 72 bps, respectively. Wells Fargo is at 53 bps.

Goldman Sachs’ relatively wider spreads are not a concern for Doucette.

“When you get spreads below 100 [bps], it’s an indication that these banks are pretty well-capitalized, so I don’t think there’s a huge credit risk issue here,” he said.

“You get a minimum guaranteed of 51% if the market is up or even flat. That’s a neat range. It gives you a minimum of 8.5% per year. If it’s higher, you’re long the index and you have no cap.

“On the downside, you have a 70% barrier. If you’re not down by more than 30%, you could significantly outperform the market.”

Long bull, short bear

While it’s impossible to predict whether 30% of contingent protection will be enough in six years, Doucette said the long duration plays to the advantage of investors given today’s market. As the current bull market nears its seventh anniversary, compared with a historical average of three and a half years, a bear market is in the cards sooner than later, he said.

“If we’re going to have a bear market, it will happen way before this note matures,” he said.

“If history repeats itself, the average bear market lasts 14 months. The market will drop and move back up again within the timeframe.

“You can only guess ... but I have a hard time to believe that we’re going to be down 30% six years from now.

“Then the question becomes, is it necessary to have that barrier on a six-year? Maybe you want to have a little bit more on the upside.”

More

“A lot of folks are predicting that in the next few years, we’re not going to see the 8% to 10% historical average. Instead they think it’s going to be more like 5% to 8% return. If you consider all the prognostics, 8.5% isn’t bad,” Doucette said.

Doucette said that both the upside and the downside terms are attractive. At least the structure enables investors to outperform in both directions, which is one of his main goals when investing in a structured note.

Looking at the risk-reward of the product, Doucette said he would be inclined to boost the return even if the market risk at maturity is not predictable.

“You’re long the index. You have protection on the downside. The two moving parts are your minimum return and your barrier assuming you keep the six-year term,” he said.

“I may be inclined to give up 5% of the barrier and to move up the step to 10% a year.

“I would still have a 25% barrier in six years with a minimum return of 10% a year.”

Opportunity cost

Jack Ablin, chief investment officer at BMO Private Bank, looked at the “opportunity cost” of the note and concluded that the “real” trade-off remains attractive.

“Your cost per year is your dividend plus the spread,” he said.

The dividend yield for the S&P 500 index is 1.98%. He assumed a 1.75% yield for a six-year Treasury. He then added the CDS spread of 84 bps.

“Your opportunity cost is about 5%. But if it’s flat or positive, the note gives you at least 8.5%,” he said.

“What’s the probability of the index falling more than 30% in six years? I would have to guess, but I’d say ... no more than 15% to 20%.”

Dividing the 5% opportunity cost by the probability, he pointed to a final opportunity cost of 6.25%.

His calculations do not include the fee, however. Those were not disclosed in the prospectus.

“The market is expensive, but you’re getting 2% above. For that opportunity cost, you get that minimum return, the unlimited exposure to the index and the protection.

“I would say it’s a pretty interesting note.”

Goldman Sachs & Co. is the agent.

The notes will price on Friday and settle Dec. 28.

The Cusip number is 38148TJZ3.

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