Goldman Sachs' digital notes linked to S&P 500 index seen as priced well in current bull run

By Emma Trincal

New York, March 15 - Goldman Sachs Group, Inc.'s upcoming 0% index-linked digital notes tied to the S&P 500 index offer a moderate risk exposure even in today's overbought market, said Matt Medeiros, president and chief executive officer at the Institute for Wealth Management.

That's because the risk of underperforming the index is minimal due to the recent equity rally, and on the downside, the structure offers a bigger-than-average buffer, he added.

The notes will mature 14 to 16 months after issue, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes at or above 85% of the initial level, investors will receive the threshold settlement amount of $1,071 to $1,083 per $1,000 principal amount. Investors will be exposed to any losses beyond 15% at a rate of 1.1765% per 1% decline.

The exact maturity date and digital payment will be set at pricing.

Medeiros said that the notes are relatively short term, a factor that limits risk. The underlying asset, the U.S. equity benchmark, displays less volatility than other benchmarks or single stocks.

15% buffer

The 15% buffer is relatively competitive in today's market for short-term products, Medeiros noted.

Issuers that offered 15% buffers last week either used a more volatile underlying such as the price of gold, extended durations beyond 18 months - in one case, up to three years - or kept the duration short but included some leverage on the downside, as with this deal, according to data compiled by Prospect News.

"I don't see a pullback of more than 15% in that timeframe," Medeiros said.

"I'm still bullish, although I am less bullish now as the market has already gone up much quicker than I anticipated."

Upside risk

Medeiros noted that the digital payment of 7.1% to 8.3% is also a cap. But the level, he said, is justified given how much the market has already risen.

On an annualized basis, investors will see their returns capped at 6% to 7% depending on the final terms set at pricing.

Part of the risk with a capped payout is the opportunity cost, said Medeiros. If the index finishes above the cap, investors in the notes will underperform the index.

But Medeiros said that the upside risk is limited.

"The S&P 500 has already gone up considerably; it's up more than 10% so far this year," he said.

"Will it continue to grow exponentially? We don't see it happening. We think that most of this rally has already happened in the first 90 days of this year.

"Investors concerned with the downside risk should decide whether they see a sell-off looking forward or a slowdown," he added, noting that bears should not consider the note.

Medeiros said that his outlook is not bearish, although one factor remains more difficult to predict.

"A lot of the bond money has been flowing into equity just to chase higher yields," he said. "This risk-averse capital is a source of volatility.

"How fast would those conservative investors run for the exit if you see a 5% correction? That's the type of thing that one needs to take into consideration because it will impact market prices.

"By having a downside protection and the cap on the underlying, the potential for upside is minimized with this note, but at a relatively acceptable level."

Not conservative

Rachelle Taqqu, principal at New Vista Capital LLC, said that she is not comfortable with the product based on the risk tolerance of her clients.

"You may or may not get your principal back at maturity as it depends on the market fluctuations," she said.

"It doesn't belong to a conservative portfolio, certainly not for the investor over 50, and I don't know how attractive it could be unless you have a view that the market is going to move sideways.

"When it comes to structured products, I like to keep the basic level of protection before looking at the upside.

"You're betting your lunch money with this product. You're taking some market risk, and you're still subject to the credit risk."

Goldman Sachs & Co. is the underwriter.

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