Goldman’s $80.03 million notes tied to index basket aimed at bulls seeking diversification

By Emma Trincal

New York, Jan. 28 – Goldman Sachs Group, Inc.’s $80.03 million of 0% leveraged notes due Sept. 9, 2016 linked to a basket of indexes was the top deal to price last week, grabbing investors’ attention for the notes’ high return potential and diversified exposure to global equity while keeping the maturity short, sources said.

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 triple the basket return, subject to a maximum settlement amount of $1,262.50 for each $1,000 principal amount.

Investors will share in losses.

Yield

“It’s a classic illustration of how to use dividends to price a decent return on a short duration,” a market participant said.

“Especially the use of the Euro Stoxx that has a 3.75% yield...that gives you triple the performance in the first 26.6%.”

The cap represents with compounding a 16.80% annualized return.

“If the basket is up just 8.75% after two years, you can capture the maximum return,” he said, adding that a 26% return over 18-month was relatively high or at least above expectations for many investors.

“The idea behind the note is: I don’t think the market will make 26% in 18 months and I’m betting against that.”

Unlike the majority of leveraged notes, this one was linked to a basket of indexes rather than to a single index, he observed.

“The use of baskets can be attractive to investors. This particular one gives you a worldwide exposure. That’s a good opportunity to diversify your portfolio,” he said.

The high dividend offered by the Euro Stoxx 50 index was key in the pricing of the product, allowing the issuer to offer a relatively high cap and significant leverage, especially when the underlying is a diversified portfolio with less volatility than a single index and when the maturity is less than two years, he noted.

“The fact that they give the Euro Stoxx the highest weighting in the basket really helps given its high dividend yield carried by this index,” he said.

“The 18-month allows you to include in the pricing two periods of dividend payments for the Euro Stoxx because this index, unlike U.S. indices, pays dividends each year. So you get a year plus half-a-year worth of dividends.”

For bulls

The full downside risk exposure was to be expected, he said.

“It’s got to be that way with that type of structure,” he said.

“It would be impossible to price this note with a barrier or buffer on such a short term.

“You get three-times to the upside. You have to pay for this in some way.

“This is for people who are actually bullish.”

Diversification

The notes also offered an efficient alternative to a direct exposure to the five different benchmarks, said an industry source.

“You’re achieving immediate diversification. You’re getting it with three times the return, which makes sense in a stagnant market,” he said.

This source agreed that the introduction of a buffer or barrier was just not an option for this type of short-term, highly levered product with a competitive cap.

No downside leverage

“There’s no downside protection, true. But that’s the essence of what investors do. You have the liquidity factor. But you always have a secondary market unless there is a catastrophe, something like a Lehman Brothers scenario,” he said.

Compared to an equivalent equity exposure, the product offered less risk.

“With the notes, you can achieve leverage without leveraging your downside risk. You’d be assuming a similar downside risk, a three-to-one downside, if you bought a bunch of mutual funds, which is what people do,” he said.

“If I want exposure to global equity, I may buy this note and decide not to touch it for 18 months.

“The 26% cap is attractive. No one is hoping for more than that, especially in a basket.

“What you’re getting is a well-diversified portfolio that is likely to outperform the underlying basket with a three-to-one upside exposure. You’re getting all this in less than two years. No one would expect having any downside protection with this type of product. This is essentially a bullish play.”

The notes (Cusip: 38148L361) priced on Jan. 22.

Goldman Sachs & Co. is the agent.

The fee is 1.45%.

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