GS Finance’s $5.03 million autocalls on Dow, S&P more likely to be one than three years long

By Emma Trincal

New York, Feb. 27 – GS Finance Corp.’s $5.03 million of 0% autocallable index-linked notes due Feb. 20, 2026 tied to the S&P 500 index and the Dow Jones industrial average could be called after one year or mature in three. Each one of those two scenarios come with very different outcomes. Advisers were willing to bet that the odds of a call would prevail. Yet they drew opposite conclusions.

If each index closes at or above its initial level on Feb. 20, 2024, the notes will be called at par plus a 14.6% call premium, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and each index finishes at or above its initial level, the payout will be par plus 1.5 times the return of the laggard index.

If the worst performer declines but finishes at or above 70% of its initial level, the payout will be par.

Otherwise, investors will lose 1% for every 1% decline of the worst performer from its initial level.

Credit, correlations

Steven Foldes, wealth manager and founder at Evensky & Katz / Foldes Financial Wealth Management, pointed to the credit risk exposure and dispersion risk first.

“We’re comfortable with Goldman Sachs even though its credit is the weakest of the major U.S. banks. But we don’t love three-year notes and we usually don’t like worst-of,” he said.

The “high correlation” between the two U.S. large-cap benchmarks mitigates the risk but doesn’t fully eliminate it.

“We saw a significant disparity in 2022. So, it’s not exactly the same as having a single index exposure,” he said.

The S&P 500 index dropped 19.4% last year while the Dow lost only 8.7%.

But those points were not central in this adviser’s analysis. Instead, his focus was on the payment of a call premium after one year, which he compared to a coupon or a cap.

Risk of underperformance

Collecting the premium is the equivalent of being capped at 14.6% a year, he noted.

For Foldes, the call would greatly limit investors’ upside potential.

“The S&P is already 17.5% off its peak of Jan. 4, 2022. For us, to do a 14.6% coupon at this point in time is a waste. If the market rebounds – and we do expect that it will – we’re only getting 14.6%. Why would you be looking at a note paying you 14.6%, which is not that much more than the historical average?” he said.

“Then on top of that you’re giving up dividends.”

The dividend yield for the S&P 500 index is 1.76%. The Dow yields 2.13%.

Historically the average performance for the S&P 500 after a down year is 15%, Foldes added. He expects U.S. markets next year to return “much more than that.”

“A year from now you could have a cessation of the hostilities in Ukraine and a resolution to the conflict. The Fed has been hiking rates eight times since March of last year. They’re probably a lot closer to the end of this tightening cycle than most people think.

“We’re almost 14 months into a bear market. The chances of a recovery a year from now are pretty significant given that bear markets on average last a little bit longer than a year,” he said.

Upbeat outlook

Yet talks of a recession, concerns over a sticky inflation and a worsening of the conflict in Europe abound on the Street, he said.

“Of course, you can always imagine the worst. People are now thinking of a possible third world war. Some are worried about Putin launching nuclear missiles.

“My view is more optimistic, more bullish.

“This note is for someone who would be bearish or neutral,” he said.

What happens if the notes mature is the most attractive scenario. It’s also the less likely, he said.

“If you get past the first year, you end up with uncapped leveraged gains, which would be very nice in a bull market,” he said.

But while bullish, Foldes still wants downside protection over a three-year timeframe.

“I don’t like the barrier,” he said.

“While it’s unlikely that the market will be negative in three years, I would still want a buffer,” he said.

To improve the structure, Foldes suggested raising the call premium. Another solution would be to replace the barrier by a buffer.

“But following my logic, raising the fixed return makes more sense. The odds of being called in one year are much too great,” he said.

At this point in the market cycle, Foldes rejects most notes limiting his upside potential whether it be via a cap, a coupon, a digital or a call premium.

“We have a positive outlook given that we’ve already had more than a year of a bear market,” he said.

“Over the past few months, we simply have switched from structured notes to long positions. We buy the index funds directly.”

Shorter duration

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would be satisfied with the 14.6% call premium if the notes were called.

“I would do it,” he said.

“I usually don’t like worst-of, but these are two large-cap indices. They’re likely to move in the same direction.

“A three-year may be a long time but it doesn’t matter here. I don’t think you get the three-year. What you’re looking at is a one-year note.”

Expecting a call

Kunhardt said he would first turn his attention to the macroeconomic outlook.

“When do we turn the corner? Next year? In the summer? The S&P is up almost 4% year to date. To me we already turned the corner, weeks ago, months ago. Everybody is lagging on when the downturn ends,” he said.

Whether U.S. large cap benchmarks recover fully during the third quarter or at the end of the year was “irrelevant,” he said.

“What matters is this: Is the market likely to be up from today to February 2024? My answer is: resonantly yes.

“It doesn’t even have to be up. It could be zero.

“Then the next question becomes: how greedy do I want to be?”

Meeting expectations

Based on the Mercer long-term return forecasts, Kunhardt expects U.S. large cap to return about 6.4% over the next year.

“I’m not a forecaster, I’m not an economist. But if all it has to happen is for large-cap stocks to be flat or better, I’m taking it.

“We just had a fairly big dislocation. So, I expect the market to be positive in one year. But I don’t know that.

“Do I hold the position long with risk? I’m not a return-chaser. If I expect 6.4% and get 14%, it’s a no-brainer.

“I’m an asset allocator. My job is to build a portfolio designed to deliver returns that exceed expectations while managing risk. I’m in,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on Thursday.

The Cusip number is 40057PHJ4.

The fee is 0%.

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