GS Finance’s $1 million bearish notes on Nasdaq offer hedge, full protection but at a cost

By Emma Trincal

New York, Nov. 14 – GS Finance Corp.’s $1 million of 0% bearish absolute return index-linked notes linked to the Nasdaq-100 index due March 28, 2025 give investors a chance to get inverse leveraged participation in the index decline with full principal protection, which could be used as a hedge, an adviser said. But the hedge, the leverage and the protection come at a cost, a financial adviser noted.

If the index finishes at or above the initial level, the payout at maturity will be par, according to a 424B2 filing with the Securities and Exchange Commission.

If the index declines by no more than 40%, the payout will be par plus 1.26 times the absolute value of the index return.

If the index declines by more than 40%, the payout will be par.

Hedge

“This is a great hedge if the Nasdaq is down. There’s potential for upside if the index is down anywhere up to 40%. And even if it drops more than that, it’s still a hedge,” said Tom Balcom, founder of 1650 Wealth Management.

“Losing nothing instead of losing 40% or more, that to me is a great hedge even though technically, not a pure hedge. But it’s a nice way to protect your portfolio.”

Full protection

Investors also get their money back if the index finishes positive.

“Your investment is not at risk, at least, you don’t have exposure to the market. You’re getting your money back.

“Your only exposure is to the issuer’s credit and we’re talking about Goldman on a very short tenor,” he said.

The principal-protection contrasted sharply with other recently issued bearish notes, which offer no protection when the market finishes positive, he said.

“Perhaps the probabilities for the Nasdaq to be up in 17 months are very low. That would explain how they were able to price the full principal protection over such a short period of time,” he said.

Bearish play

The notes could also be used as a directional play.

“If you have a bearish outlook, it’s great too.”

Many factors could justify a short-term bearish view, he noted.

“You have next year’s Elections, which will add significant volatility to the market.

The highly valued tech stocks and the index’s performance concentrated around a small number of them was also a factor of instability, he noted.

“If tech gets hit again as it was last year, you could see a big sell-off in the sector. The note allows you to monetize that,” he said.

Geopolitical risks also had to be factored in.

“We now have regional wars in Ukraine and in the Middle East that may turn into bigger wars,” he said.

Balcom said the minus 40% threshold was appropriate.

“I don’t expect the market to drop more than 40%. That would be a pretty severe decline. But even if it happened, you wouldn’t lose any money. That’s very attractive for conservative investors,” he said.

Opportunity cost

Steve Jon Kaplan, founder and portfolio manager with True Contrarian Investments, held a different view.

“I don’t like the fact that below -40%, you lose all of your potential gains. You may get your money back, but your return is zero. This is not a cap,” he said.

If the minus 40% level had been a cap, he explained, a 41% decline in the index would have caused investors to give up the additional 1%, not 41%.

“Here, you’re getting 0%. They’re taking away your return. You’re only getting par. It’s a waste because in all likelihood, this -40% barrier is going to be breached,” he said.

Shark note

The structure borrows some of the characteristics of a so-called “shark note.” Shark products are typically principal-protected. The main feature is the cancellation of all the gains once a barrier is knocked out, which is the case with this note. Very often, shark barriers are observed on any trading day, which does not apply to this structure.

The term “shark” refers to the fin-like shape of the payout on a diagram, with the return falling down to zero once the barrier is breached.

“I think they could have taken the leverage out. It’s not needed. The Nasdaq is going to drop 40% even without leverage. The leverage is a luxury,” said Kaplan.

“If you could get more than the 40% range and eliminate the leverage, it would be much better.”

But for Kaplan, the most important thing was to eliminate the “fin” of the shark structure and reestablish a normal cap in place of the knock out.

Strongly bearish

“This note is poorly designed. You should be able to keep your absolute return once you hit the barrier. It should be a traditional cap, not this,” he said.

“Without a real cap, you’re giving up a huge potential. You end up with nothing.”

Kaplan said the note may catch investors’ attention for its capital protection. But the odds of getting just that – the mere principal at maturity – were too high to justify allocating money in the note, even for a short period of time.

“I can’t predict when the Nasdaq will be down more than 40%. But I am confident that at some point it will be down even more than 40%. When? Hard to say because we will have some rebounds before hitting bottom.

“But with a benchmark trading more than triple its fair value, I think we’re likely to see at some point a 75% drawdown.

“This note is forcing you to leave too much on the table,” he said.

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

Goldman Sachs & Co. LLC is the agent.

The notes settled on Monday.

The Cusip number is 40057WZC4.

The fee is 1.07%.

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