Goldman’s PLUS tied to S&P 500 offer short-term leveraged bet, but risk, cap hurt scores

By Emma Trincal

New York, Oct. 21 – GS Finance Corp.’s Performance Leveraged Upside Securities due Feb. 5, 2018 linked to the S&P 500 index offer high leverage and a “decent” cap, but the lack of downside protection had a negative impact on the product’s scores, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus 300% of any index gain, up to a maximum return of 13.9%, with the exact cap to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be exposed to any losses.

Mild bulls

“This note has good leverage and a decent return but on the downside you’re totally exposed,” Vile said.

“Investors in the notes are bullish to the extent that the index needs to go up to make money, unlike an autocall or a digital.”

“They’re also bullish because they don’t need the downside protection apparently.

“On the other hand, anyone considering this product must have pretty low return expectations. So it’s for a moderately bullish investor.”

The product can deliver up to 11% in annualized return on a compounded basis. The 15-month notes may reach this cap if the index rises as little as 3.70% a year, he noted.

“You’re not expecting too much from the market. You can get as much as 11% a year, which is not bad. But you can lose 100% of your investment for that,” he said.

“You might expect that the market will still be up but that after this long bull market, returns will be subdued. It has become a prevailing view among some analysts.

“A more bullish investor would probably choose less leverage, for instance two times with a higher cap, let’s say, around 120%.”

Risk

Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others, including its peers and all products.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product, with 10 being the highest level of risk possible.

The notes have a 2.91 market riskmap versus an average of 1.75 for the same product type, according to Future Value Consultants’ research report.

“It’s expected when you get no downside protection. This product competes against other leveraged return notes, and those very often offer a buffer or a barrier,” he said.

The S&P 500 index helped somewhat, he said.

“A note like this one with no downside protection but linked to Netflix would have a much higher market riskmap of course,” he said.

Credit

The credit riskmap of 0.46 is the same as the average for the leveraged return product type, according to the report.

“This has a lot to do with the short maturity, not so much the issuer,” he said.

Goldman Sachs has some of the widest credit default swap spreads among larger U.S. banks at 90 basis points, according to Markit. Morgan Stanley comes closely after with 86 bps. But other firms are showing tighter spreads: 77 bps for Bank of America; 76 bps for Citigroup; 61 bps for JPMorgan; and 57 bps for Wells Fargo, according to the financial information services company.

Adding the two risk components gives a 3.37 riskmap, which is more than the average of 2.21 for similar products.

This elevated riskmap will have an impact on the risk-adjusted return of the investment, as measured by Future Value Consultants with its return score, he explained.

Return score

The return score measures the risk-adjusted return of a note on a scale of zero to 10. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The return score for the notes is 7.13 versus an average of 7.45 for similar products and 7.16 for all products.

“It’s not too bad when you compare the score with all products. A cap never helps the return score. Still this one is 11% a year, which is decent. The problem is mostly the risk. The high riskmap really hurts,” he said.

Value

The value of the notes, as measured by the price score on a scale of zero to 10, is a little bit more disappointing, he said.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

At 7.67, the price score is much lower than the 8.76 average for the same product type, the report showed.

“It’s still in the top quartile, but compared to the average, it’s not so great. You get hit with a cap. Even if it’s a reasonable cap, it’s still a cap and you have no downside protection.

“They probably could have spent a little bit more to raise the cap. You’re not getting enough for the unlimited downside risk,” he said. “A little bit of protection would have helped a lot.”

The short maturity also contributed to the lower score as there is less time to amortize the cost of the notes over a shorter period of time.

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an overall score of 7.40 versus 8.11 for the average leveraged return note and 7.76 for all products.

“Perhaps the score reflects the hybrid nature of the investment theme,” he said.

“This note reflects a mildly bullish outlook with some risk tolerance. One of its advantages is the short time horizon. Investors like it. They get to reinvest soon.

“The leverage helps you pick up a decent double-digit return. If the market has a mediocre performance, if it’s up 4% a year, you get 11%. But of course if it’s negative you have no protection at all.

“This product scores lower than average mainly because of the higher risk.”

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. is the underwriter with Morgan Stanley Wealth Management as dealer.

The notes will price on Oct. 31.

The Cusip number is 36250Y882.

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