Goldman's leveraged notes tied to Russell 2000 offer small cap play but value is below average

By Emma Trincal

New York, Jan. 4 - Goldman Sachs Group, Inc.'s upcoming 0% leveraged buffered notes due Feb. 3, 2015 linked to the Russell 2000 index are designed for investors seeking exposure to small-cap stocks but the terms of the product are not among the best when compared to other recently rated leveraged notes in general, said Suzi Hampson, structured products analyst at Future Value Consultants.

The payout at maturity will be par plus double any index gain, up to a maximum return of 20% to 22%, with the exact value to be determined at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 10% and will lose 1% for each 1% decline beyond 10%.

Future Value Consultants rates structured notes using different scores and it compares products across similar structure types. The upcoming notes belong to the leveraged products structure type, Hampson explained, which is broadly defined: it includes all underliers, maturities and levels of protection, including none.

Higher risk

"Despite the 10% buffer, one interesting thing is the higher level of risk in this product," she said.

Future Value Consultants measures the risk associated with a product on a scale of zero to 10 with its riskmap. The higher the riskmap, the higher the risk of the product. The riskmap is the sum of two risk components: market risk and credit risk.

The notes received a 4.42 riskmap compared to 3.83 for the leveraged product type.

"Several factors contribute to increase the riskmap here," she said.

"It's a two-year, which is quite a longer maturity than the average similar product. Most leveraged notes usually run between one year and 18 months.

"That difference has an impact on the credit risk, which [at 1.14] is greater than the [0.91] average for the same product type.

"You also have the 10% buffer. Ten percent is not bad but you would see it mostly on a one-year. But this is a two-year and it's not based on the S&P 500," she said.

The one-year implied volatility for the Russell 2000 is 21% versus 17% for the S&P 500 index.

"The difference in volatility it is not huge in magnitude. But it has an impact," she said.

"As a result, the market riskmap at 3.27 is greater than the [2.92] average for the same product type.

"Overall the higher riskmap is not surprising. If you have more credit risk and more market risk and you add them together it gives you a greater level of risk," she said.

Lower return score

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions - neutral assumption, high and low growth environments, and high and low volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios

With this product, she said, the best scenario used for the calculation of the score is high growth.

"That's because the more you move away from the buffer, the lower the chances of losing capital and also the more chances you have of getting the maximum return," she said.

Under this market assumption, investors have a 6.2% probability of earning a 5% to 10% annual return versus an 11% probability of losing more than 15% per year.

But given the competition among issuers for those leveraged products, the notes show a return score one point lower than their counterparts as a whole at 6.35 versus 7.32 respectively.

"It means that for the amount of risk you're taking, there are products available out there that will give you a higher return," she said.

"It could be another Russell 2000 note with a higher cap or a product with less risk and a similar cap."

"The lower return score suggests that the potential return of this product is less than average. If the score is lower it simply is because other products out there score better.

"Investors tend to use the Russell versus the S&P when they seek much higher returns. It fits a higher risk/higher return profile.

"Among the better scores you could have some S&P products scoring better but with a lower cap because the risk is lower. This one, if it's based on a more volatile index, could for instance offer a higher cap."

Getting exposure

Future Value measures a note's value to the investor on a scale of zero to 10 via its price score. 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.

The notes have a lower price score of 4.77 versus 7.34 for the same product type.

"This is not surprising. The low return score and the low price score are usually correlated. If the price score is high the return should be high as well," she said.

Leveraged notes represent quite a competitive category, she said, which is a factor that also tends to drive pricing.

"A lot of firms are issuing this type of products. As a result, you would expect this one to price more aggressively as opposed to pricing a less standard product," she said.

The return score when compared to all product types, including reverse convertibles, is "not too bad", she said, with the score for all product types at 6.58.

"But when compared to other leveraged notes, it's below average. The notes are not offering particularly attractive terms based on the risk. You probably should have a higher cap or a higher gearing or a shorter maturity. This is a normal leverage return structure, in which you're looking to benefit from moderate gains in the underlying with a chance of outperforming the index. Plus you get the 10% buffer.

"It is a well-known and popular structure, which is why issuers keep bringing it out.

"The Russell 2000 is probably the best way to get exposure to small-cap stocks. You have to believe that the Russell was the draw for this product, because you don't have anything else standing out," she said.

Future Value Consultants measures the quality of a deal with its overall score, which is simply the average of the price score and the return score.

The overall score of 5.56 for this product is "way below" the 7.33 average for this product type, she said.

The score is also lower than the average of all products, at 6.74, she noted.

"It doesn't look like the product has good value compared to many other things available out there," she said.

Goldman Sachs & Co. is the underwriter.

The Cusip number is 38141GLS1.

Pricing is expected to be on Jan. 31.

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