GS Finance’s $964,000 autocalls on S&P, Russell Value suggest new sector rotations

By Emma Trincal

New York, Nov. 18 – GS Finance Corp.’s $964,000 of 0% index-linked notes due Nov. 6, 2025 tied to the lesser performing of the S&P 500 index and the Russell 2000 Value index may reflect investors’ recent interest for cyclical and value stocks, sources said.

The notes will be called at par plus a 7.5% annualized premium if both indexes close at or above their initial levels on any annual call observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 37.5% if each index finishes at or above its initial level. If either index falls but not below 65% of its initial level, the payout will be par. Otherwise, investors will lose 1% for every 1% that the lesser performing index declines.

Flight to value

The Russell 2000 Value index has gained more than 18% since the end of October.

Positive news around Covid-19 vaccines sparked a value and cyclical rally on hopes that beaten up stocks may benefit from a reopening of the economy.

“People have been saying it’s going to be the year of value. Value is going to outperform growth. We’ll see if it’s going to be the case,” a trader said.

“But as a way of gaining exposure to this concept, adding a value index to the S&P isn’t a bad idea.

“The S&P could end up being the kicker to get the higher coupon. The low correlation might help too.”

The correlation between the S&P 500 index and the Russell 2000 Value index is 0.887 which is lower than that between the S&P 500 index and the Russell 2000 at 0.93.

The lower the correlation between two underlying, the higher the premium paid for the dispersion risk.

A new trend

Traditionally, worst-of notes including small cap equity consists of combining the S&P 500 index with the Russell 2000 index.

“The Russell 2000 Value may be a new potential asset class reflecting a new view on the market,” a market participant said.

“The twist here is to take the value segment of the small-cap market. It just gives you a variation on the S&P/Russell theme. My guess is that it probably leads to better pricing. The correlations are different.”

“For those who have already invested in notes tied to the S&P and the Russell 2000, it provides a little bit of diversification. You’re playing into the theme of the value sector,” he said.

“The call premium and the barrier level are decent.

“It looks very solid.”

Less common structure

Beyond the appeal for a new market theme, the offering may have responded to some investors’ demand for a particular type of structure called “snowball.”

Those types of autocalls are much less common than their “Phoenix” counterparts, which are the traditional and prevalent contingent coupon autocallable notes.

With snowballs, investors only get paid upon the call, receiving a premium instead of a contingent coupon.

Because continency is paid at the call trigger level, or initial price, rather than at a lower strike as it is the case with the Phoenix, the call premium in a snowball will typically be higher than a contingent coupon.

Other advantages of snowballs include a feature named memory, which allows for the cumulation of previously unpaid call premium upon early redemption or at maturity.

Many benefits

“Some people really like call premium structures like this one,” the market participant said.

“It’s a simple structure. It also offers a more efficient tax treatment,” he said.

Since the call is usually scheduled on an annual basis, the tax treatment is long-term capital gains.

“You also get the accumulated premium, so if you get called you never miss any previous payout.”

Other advantage: the higher payout.

“The call premium tends to be higher than the contingent coupon because the market needs to be up.”

Finally, investors in snowballs get paid the full annualized call premium as opposed to Phoenix investors who may only receive a fraction of the annualized return if called after one month or one quarter.

“What the Phoenix does for you is to pay you a coupon even if the market is down 15%, 25% or 30% depending on the barrier.

“These are significant differences,” he said.

Cash flow first

The trader said that there is a reason why snowball products are less popular than Phoenix notes.

“They’re not income,” he said.

“People are interested in snowballs. Advisers like it. But we do see more Phoenix.

“At the end of the day, investors want the regular income. Yes, the call premium offers a higher yield. But you don’t have that cash flow.

“Some people classify these snowballs as income products but it’s a little bit misleading. It’s a bullet payment up to a call. Yes, you can get 10% instead of 7.5%. But you may wait two years.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes priced on Oct. 30 and settled on Nov. 4.

The Cusip number is 40057EGW1.

The fee is 4.45%.

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