GS Finance’s autocalls on biotech ETF to pay double-digit return in sector rattled with fear

By Emma Trincal

New York, June 3 – GS Finance Corp.’s 0% autocallable notes due June 14, 2022 linked to the SPDR S&P Biotech ETF come at a time when drug makers are facing increasing political risk putting the sector under pressure. The notes paid a double-digit return and offer a contingent protection on the downside. As always investors need to decide whether they are getting adequately compensated for the risk taken, advisers said.

The notes will be automatically called at par plus an annualized call premium of 11.5% if the ETF closes at or above its initial level on any annual review date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 34.5% if the ETF finishes at or above its initial level. If the ETF declines by up to 30%, the payout will be par. Otherwise, investors will be fully exposed to the decline of the ETF from its initial level.

Big moves

A financial adviser noted how volatile the underlying was.

“It had quite a swing over the past five years,” he said.

The SPDR S&P Biotech ETF is concentrated in biotechnology companies, bearing the risk associated with this subset of the health care sector such as heavy investments in research and development with no guarantee of commercial success and increased government regulation, the prospectus warned.

Bull trend

So far, the “swing” has been largely bullish. The fund’s annualized return over the past 10 years was 17.94%, according to Morningstar.

In 2014 and 2017, the fund was up 45% and 44.75%, respectively. Its biggest decline was 15.44% in 2016.

The trend remained bullish so far this year with the ETF up 10.7%. But volatility has picked up since the beginning of April.

“It’s down more than 6% in the past month,” the adviser said.

“It has a beta of 1.21, which means that if the market is up 10%, this one will be up 12%, or 20% more.”

This volatility explained how the issuer was able to generate the 11.5% premium without having access to a high-dividend paying ETF, which yields only 0.18%.

From the investor’s standpoint the opportunity cost of foregoing dividends is negligible.

“It’s more of a growth-oriented sector so you’re not going to lose much in dividend,” he said.

“The volatility of this index is what generates the premium.

“Having a volatile underlying is what makes pricing feasible when there is no dividend.”

Political risks

Investors in the notes should carefully consider the nature of the risks associated with the asset class.

“Right now the risk is political,” he said.

“The political climate is a big worry if you’re investing in this sector. Recently health care has been selling off. It has become the target of all politicians ahead of the 2020 Elections, from Medicare for All on the left to Trump’s plan to cut drug prices.”

The deal is not for everyone, he added.

“It depends on the investor. It’s a healthy coupon, and if you’re happy with this rate of return and the downside protection that you get, it makes sense,” he said.

Recent price action could be enticing for tactical players.

Entry point

“If you want exposure to this sector, you’re getting in at a good time because we just had a pullback from the highs early this year.”

On the upside, the 11.5% call premium is also a cap, which may be a concern for bulls eager to seek higher gains.

This adviser downplayed the upside risk.

“You can’t expect 18% a year for the next three years,” he said.

“If you want a healthy coupon with some downside protection, this note offers a good alternative to the ETF.”

Trade war

Carl Kunhardt, wealth adviser at Quest Capital Management, said the risk-adjusted return of the notes was not satisfying.

He pointed to the escalating trade tensions between the United States and China.

“China is the biggest producer of rare earth and we import most of our supply from them. We need those minerals for technology and biotechnology. A lot of our pharmaceutical needs depend on China.

“We’re in a trade war and it’s just a matter of time before China plays its card with rare earth. Given our dependency on them, given the trade war, anyone buying this product should be rewarded adequately. I don’t think an 11.5% cap is a good reward for the risk taken.”

On the other hand, the sector could do very well.

“So many things can happen in the next three years. Let’s look at England. They pull off Brexit. We have a direct country-to-country trade agreement with them. Many pharmaceuticals companies are based in England. The entire sector could take off in this scenario.

“One way or the other, this fund is volatile...it has the potential for a big move. That’s the nature of volatility. A volatile sector has the potential for a significant downside exposure. You have some protection. But the cap is taking away the significant upside exposure, which is the purpose of volatility investing.

“I would not consider this one,” he said.

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

Goldman Sachs & Co. LLC is the underwriter.

The notes will price on June 7.

The Cusip number is 40056FJZ9.

© 2015 Prospect News.
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