Goldman Sachs’ PLUS linked to Financial Select Sector SPDR offer alternative to long-only play

By Emma Trincal

New York, July 29 – GS Finance Corp.’s 0% Performance Leveraged Upside Securities due Dec. 5, 2017 linked to the Financial Select Sector SPDR fund give moderately bullish investors an alternative to a direct investment in the exchange-traded fund, said Tim Vile, structured notes analyst at Future Value Consultants.

The notes will be guaranteed by Goldman Sachs Group, Inc., according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10.00 plus 300% of any fund gain, up to a maximum payment of $11.625. Investors will be exposed to any losses.

Terms

“For someone who is not too bullish but wants a decent return, this note can outperform the underlying given the high leverage and reasonable cap,” he said.

“But investors have to be able to take risk as there is no barrier or buffer on the downside.”

With a tenor of a little longer than 15 months, a 16.25% cap and three-times leverage, the notes offer a maximum annualized return of 12.38% on a compounded basis.

“This is a very good return, especially when you compare it with the underlying fund,” he said.

Fund performance

The fund, which gives investors exposure to the U.S. financial sector of the S&P 500 index, is flat for the year.

Its implied volatility of 15% is slightly less than the roughly 16% volatility of the S&P 500, he said.

“Not very high and still this fund has seen some movement,” he said, adding that the ups and downs were correlated with the broader market, in particular around the mid-February correction and the day following the Brexit vote at the end of June.

“An American barrier would have created some risk since this fund can go up and down easily. But having no protection at all is still the riskiest proposal,” he said.

So-called American barriers can be triggered on any trading day, making the loss of protection more likely to occur than when the observation is at maturity. When the barrier is hit, the protection disappears. With the notes, the protection is just not in place.

Mildly bullish

Investors in the notes represent a particular kind of bull, he said.

On the one hand, the underlying only needs to be up 5.42% over the term for investors to receive the maximum gain.

“That isn’t much at all. You’re obviously not expecting a very bullish scenario. But the 16.25% return is quite competitive because of the amount of leverage you’re getting,” he said.

On the other hand, investors still have to be optimistic about the fund performance.

“You’d have to be reasonably bullish to take on that kind of risk since there is no downside protection at all,” he said.

Future 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 notes fit into the “leveraged return” category in Future Value Consultants’ methodology. This product type encompasses any note with an upside participation rate greater than 100%. The category enables the research firm to compare the product with products of the same structure type when assigning scores.

Risk

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 as the highest level of risk possible.

The notes have a 3.96 market riskmap versus an average of 2.21 for the same product type, according to Future Value Consultants’ research report.

“This is very easy to explain: you have no downside protection and you’re comparing this note with others that precisely have some form of downside protection, either barriers or buffers,” he said.

The credit riskmap is 0.46, equal to the average for the same product type, the report shows.

“The shorter investment period should cut credit risk, but the wider credit spreads of the issuer offset that advantage, so you end up with something average,” he said.

The credit default swap spreads of Goldman Sachs are 97 basis points versus 95 bps for Morgan Stanley, 80 bps for both Citigroup and Bank of America and 61 bps for JPMorgan, according to Markit.

When adding the two risk components, the report shows a 3.96 riskmap, which is higher than the 2.21 average for similar products and the 2.17 average for all products.

“There’s nothing surprising here. The product offers no protection and still a reasonable level of credit risk. You get a riskmap that’s higher than average,” he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets, and high- and low-volatility environments. The score is computed based on the best among five market scenarios. For the product, the optimal market is bullish.

The return score is 7.10 versus an average of 7.45 for similar products, according to the report.

“The 12.38% cap is not too bad for a capped product, but caps always hinder the return score. Also, you have this elevated risk level. Consider the cap and the risk level [and] it makes sense that you’re not going to get a massive return score. To improve this score, the issuer would have had to raise the cap. Adding a protection may have helped too, although the cap may have been lower.”

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. 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 7.16, the price score is lower than the 8.76 average for the same product type.

“It’s still good. I consider seven as a magic mark,” he said.

In general, short-dated products offer poor price scores as the fees are spread out over a short period of time.

“In this case, the price score is still OK. It means that they have spent a reasonable amount on the options,” he said.

“Capped products usually offer some downside protection, which they did not build into this note. But they paid a lot on the leverage, even if it’s only over a short 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 7.13 versus 8.11 for the average leveraged return note and 7.73 for all products.

“This product is average but decent. It gives you a reasonable cap of 16.25% for about 15 months. There is no protection, but the underlying index is not that volatile. The good part is the leverage. Three times can help you outperform the fund,” he said.

“Any investor looking for exposure to the financial sector may get a better return on the upside without being worse off on the downside.”

He added that investors in the notes get the leveraged exposure on the upside only.

“Somehow the structure limits your downside risk as well. Having leverage on the upside and a one-to-one exposure on the downside makes this product a better alternative than a long-only investment if you don’t expect a huge return.”

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

The notes will price on Aug. 17.

The Cusip number is 36250Y429.

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