GS Finance’s notes tied to Nasdaq-100 Tech and Nasdaq-100 index offer leverage, minimum return

By Emma Trincal

New York, April 28 – GS Finance Corp.’s 0% five-year notes linked to the least performing of the Nasdaq-100 Technology Sector index and the Nasdaq-100 index offer a worst-of leveraged upside with a minimum return if the worst-performing index is positive, making the product slightly different from the standard plain-vanilla leveraged note.

It also creates a hybrid structure half-way between a digital note when the return is below the minimum threshold and a leveraged uncapped note, if higher, advisers said.

If the final value of each index is positive, the payout at maturity will be par plus the greater of 140% of the lesser-performing index’s return and par plus 15%, according to a 424B2 filing with the Securities and Exchange Commission.

If the lesser-performing index declines by up to 25%, the payout at maturity will be par.

If the lesser-performing index declines by more than 25%, investors will lose 1% for each 1% decline of the lesser-performing index from its initial level.

Fair risk-reward

An adviser said the terms were relatively attractive except for the tenor.

“It seems reasonable from a risk-reward perspective,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“But I don’t like the five-year.

“At the same time, investing in stocks requires time. If you’re going to invest in the market and in tech stocks, no matter where the market is going, five years is pretty standard.”

But a five-year long-only investment in those two indexes is different than buying a five-year note tied to the same indexes.

“To me, five years is a long time,” he said.

“I don’t really like the limited liquidity.”

A long tenor can also mean a high opportunity cost in unpaid dividends.

In this case, however, the impact of the extended maturity was not significant.

“It’s not such an issue here because the Nasdaq doesn’t pay very high dividends,” he said.

The structure itself however was relatively attractive.

“The terms are reasonable. It’s sort of: what am I missing? It’s almost too reasonable,” he said.

Another adviser focused on two interesting characteristics of the product: the combination of a minimum return and leverage on the one hand; and the choice of the two underlying on the other hand.

“At first it seems like a great note. But it’s important to look at the details,” said Jonathan Tiemann, president of Tiemann Investment Advisors.

Weak boost

He first commented on the minimum return of 15%, which applies if the worst-performing index is positive.

“It really is a booster when the index return is very, very low. After a certain break-even, your return is 1.4 times the gain and you no longer benefit from this booster. It’s all leverage,” he said.

The break-even is a return of 10.714% in five years.

The prospectus offered some illustrations of the way the payout can evolve from digital to leverage.

If the worst-performing index finishes up 3%, investors will receive the 15% digital, which is a much better outcome than getting 4.2% in leveraged return based on the notes’ multiple of 1.4.

Another example showed a 15% payout if the return over five years is only 8%, which is still better than 11.2% from the leveraged gain although not as much as in the previous example.

Beyond a 10.714% index return at maturity, or approximately 2% a year, the leveraged payout ends up outperforming the 15% digital.

“You really benefit from this booster only if the index is hardly up. It’s hard to distinguish it from zero. I don’t think they’re giving you a lot,” he said.

Two Nasdaq indexes

The uncapped return was a positive, but it also was to be expected, he added.

“To attract capital to be committed for five years, you can’t have a cap.

“It probably helps the issuer a little bit to do it on a worst-of,” he said.

But the issuer chose to use two underlying indexes, which at first appear to be correlated.

“It’s an intriguing pair,” he said.

The Nasdaq-100 index includes 100 of the largest domestic and international non-financial securities listed on the Nasdaq Stock Market based on market capitalization.

The Nasdaq-100 Technology Sector is an equal weighted index with 41 components including technology stocks in the Nasdaq-100 index.

Market cap

“They look like they’re highly correlated, almost perfectly correlated. So why did the issuer need to do a worst-of on two underlying there?” he said.

The correlation between the two indexes is 0.98 on a 120-day period.

It is unclear how the indexes behave over a longer timeframe, he said.

“It’s hard to tell. But they may be more different than they look,” he said.

One important difference was the weighting: the Nasdaq-100 is a cap-weighted index while the Nasdaq-100 Technology Sector index is equally weighted, he noted.

“It’s not exactly the same thing,” he said.

“With market-cap indices, you’ll outperform if the large-cap stocks outperform because they are overweight large-cap. But if smaller caps outperform, you’re better off with equally weighted indices.

“So, there is a difference here. It’s based on how smaller stocks do relative to large-cap stocks.”

Timeframe

However high the correlation between the two may be, the indexes in a worst-of could not be identical otherwise there would be no value added to the structure, he explained.

The other terms, including the 75% barrier and uncapped upside, were “fine” for investors willing to invest over a longer timeframe, he said. But Tiemann said he would not consider buying the product because of that.

“I don’t particularly like the notes. The five-year tenor is a strong disadvantage for me.

“I don’t know if I want a five-year commitment to tech stocks with no flexibility to make adjustments and very little liquidity,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

The exact maturity date will be set at pricing. The participation rate may be higher than 140% and will be set at pricing.

Goldman Sachs & Co. is the agent.

The Cusip is 40057E4W4.

© 2015 Prospect News.
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