Goldman Sachs’ leveraged buffered notes tied to index basket offer no cap, diversification

By Emma Trincal

New York, Nov. 18 – Goldman Sachs Group, Inc.’s 36- to 39-month 0% leveraged buffered notes linked to a basket of indexes showed some attractive characteristics such as uncapped leverage on the upside and buffered protection on the downside, yet financial advisers said that some of the terms of the structure were still disappointing.

The notes are designed for investors seeking international equity exposure. The basket consists of the Euro Stoxx 50 index with a 37% weight, the FTSE 100 index with a 23% weight, the Topix index with a 23% weight, the Swiss Market index with a 9% weight and the S&P/ASX 200 index with an 8% weight, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket return is positive, the payout at maturity will be par plus 1.2 to 1.3 times the basket return, with the exact participation rate to be set at pricing.

Investors will receive par if the basket falls by 10% or less and will lose 1.1111% for every 1% that the basket declines beyond 10%.

The pros

“The leverage on the upside, even though it’s a modest leverage, is a good thing. Having no cap is always a good thing. The fact that it has a 10% buffer is good as well,” said Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management.

“If over the next three-and-a quarter year this basket takes off, having no cap is a winner. You’ll do a little bit better than the underlying. If it performs poorly, you have some level of downside protection with a 10% buffer.

“The notes are linked to an equity basket. It’s a reasonable basket of developed international stocks.

“There are a lot of positives in this note,” he said.

The underlying investment theme would be of interest to European equity bulls.

Europe is an important part of this basket, making for approximately 70% of it. So far the best place to invest has been the U.S. But Europe is interesting, too. If you’re looking at potentially some reversion to the mean, Europe is still relatively cheap. We do have international exposure both in developed and emerging countries,” he said. “Overall, this is not a bad note.”

Dean Zayed, chief executive officer of Brookstone Capital Management, said he liked the upside.

“The leverage is attractive and the fact that there is no cap is very appealing,” he said.

However both advisers expressed reservations about the deal.

Tenor and leverage

“The note is just a little bit longer than we would like,” said Foldes.

“Credit risk is not so much the issue. Goldman is on our approved list. We’re OK with Goldman Sachs as issuer even if they’re not the best credit.

“But we would like more upside. Typically, we do have more leverage, especially with that type of duration.

“We used to always stay shorter than three year. We have done three years recently but this one would be pushing it because it can be 39-months. We don’t like to go that long especially if the leverage is that modest. We are used to getting 1.5 to two-time leverage. I don’t know the amount of dividend you’ve given up with this basket, but that would be one of the reasons you’re looking for more upside... because you’re certainly giving up some income.”

If Foldes was to consider buying the note, he would change some of the terms.

We would look for a shorter maturity and try to increase the leverage factor even if it means exploring other markets and different indices. Emerging markets for instance could probably provide additional benefits as they tend to be more volatile,” he said.

Dilution

Zayed was more concerned by the type of underlying than by the terms of the structure.

“I am less and less attracted to notes that include a diversified basket of indices,” he said.

“I prefer products that allow the investor to make a targeted decision to get exposure to a specific index or security.

“Yes, diversification is great, but it certainly can dilute the returns when you have five indices that are not necessarily highly correlated.”

Zayed noted that the tradeoff for eliminating the cap was a small buffer, which may not be adequate to provide sufficient protection.

“If one of the three indices that this note has the most exposure to – and that’s England, Europe and Tokyo – if one of those three goes south, then it will likely dilute any upside you might have and could blow through the small 10% buffer.

“This note seems to be built to be a one-size-fits-all for the investor seeking international exposure – decent terms but nothing compelling enough to have me want to recommend it to my clients.”

The exact maturity date will be set at pricing.

Goldman Sachs & Co. is the underwriter.

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