Goldman Sachs’ 0% eight-year notes linked to Dow offer full protection for long-term play

By Emma Trincal

New York, July 16 – Goldman Sachs Group, Inc.’s 0% notes due Aug. 1, 2023 linked to the Dow Jones industrial average offer full protection against market risk for long-term investors willing to sacrifice some of the upside.

If the index return is positive, the payout at maturity will be par plus 100% of the gain, subject to a maximum payout of $1,800 per $1,000 principal amount. Investors will receive par if the index declines, according to a 424B2 filing with the Securities and Exchange Commission.

Full cycle

When an investment is that long, protection loses its relevance and is probably expensive, said Steve Doucette, financial adviser at Proctor Financial.

“We’re going eight years out, and we’re capped. Is 80% a decent return on the Dow for that period of time? I don’t know. If five years from now the market is up 100%, then what?” he said.

“Here comes the scary part: then the bear market hits. You can’t get out without severe penalties. I don’t know what they’re going to give you. Not 80% for sure. You already missed 100% of the upside at this point.

“Besides, eight years is almost a full market cycle. The protection is not appealing at all over that timeframe.

“It’s just too long.”

Taxes

In addition, Doucette said the tax treatment of the notes is not enticing.

“Everything is ordinary income. Your client gets taxed at the highest marginal tax bracket. That’s why we rarely do principal-protected notes,” he said.

The notes will be treated as debt instruments subject to special rules governing contingent payment debt instruments for U.S. federal income tax purposes, according to the prospectus. Even though investors do not collect interest, they are still required to pay taxes on ordinary income from the notes over their term based on the comparable yield for the notes, the prospectus said, describing what is referred to as “phantom” income.

Under this taxation treatment, which applies to zero-coupon bonds such as this note, investors pay taxes on an income they do not receive.

“You’d be better off with a buffer,” he said.

Buffered alternative

Wells Fargo & Co. is offering an alternative in a buffered and perhaps leveraged product also linked to the Dow.

The 0% market-linked securities with upside participation and fixed percentage buffered downside due July 31, 2020 will offer 100% to 110% participation in the upside with no cap and a 15% buffer on the downside, according to a 424B2 filing with the SEC.

“At least this one gives you the option to outperform either on the upside or on the downside,” Doucette said.

“Unless something changes drastically before they price, you’ll get some kind of leverage and the buffer comes in.

“If you get caught in the bear market, you still have 15% protection.”

The Wells Fargo notes (Cusip: 94986RXW6) are due to price on July 28.

In general, however, Doucette said he prefers notes that are linked to the S&P 500 index rather than the Dow.

“We like diversification. The Dow is only 30 stocks. You’re likely to get two or three stocks probably overvalued,” he said.

“It’s price-weighted, so something starts to go down ... and you have a problem.

“We like the S&P better. It’s a much broader index.”

Good for long term

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the duration of the Goldman Sachs notes is not really a concern.

“For somebody who has a long-term view on the Dow, I think it’s a very interesting play,” he said.

“I like the idea of principal-protected notes. They’re very attractive, especially for a long-term hold.

“A 10% cap per year is definitely within the reasonable consensus. The historical average is less than that.”

The average annual return for the Dow since 1975 is 9.9%, according to 1stock1.com.

“I don’t mind the term. These are large cap, a core asset class. You’re going to be holding it for a long time,” he said.

“And if you want, you can certainly build satellite asset classes around it to reflect shorter views.”

Goldman Sachs & Co. is the agent.

The notes will price on July 27 and settle on July 30.

The Cusip number is 38148T7B9.

© 2015 Prospect News.
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