Goldman's leveraged buffered notes tied to Euro Stoxx 50 offer attractive buffer, sources say

By Emma Trincal

New York, Oct. 21 - Goldman Sachs Group, Inc.'s 36-month 0% leveraged buffered notes linked to the Euro Stoxx 50 index offer downside protection that is attractive considering that the return on the upside is both levered and unlimited, sources said.

If the index return is positive, the payout at maturity will be par plus 110% to 120% of the index return. The exact upside participation rate will be set at pricing. If the index declines by 20% or less, investors will receive par. Otherwise, investors will lose 1.25% for every 1% that it declines beyond 20%, according to a 424B2 filing with the Securities and Exchange Commission.

Extra protection

"I like it," said Carl Kunhardt, wealth adviser of Quest Capital Management.

"Compared to other notes I've seen recently on the Euro Stoxx, you're getting the same participation rate but the return is uncapped. In addition, you are getting a larger buffer of 20%. You have to pay for the buffer, and that's why you're getting a little bit of downside leverage.

"But most comparable notes with a traditional buffer would give you a 10% protection, not 20%."

The 1.25 times downside rate for every 1% of index decline beyond the buffer is an acceptable trade-off for the uncapped upside and larger buffer, he said.

"Initially, my first impression was very negative. But when you put numbers to it, the extra 10% buffer that you're getting compared to most equivalent three-year [products] that only have 10% gives you an additional level of protection," he said.

An index decline of 30% would leave holders of the notes with a 12.5% loss, he said. In contrast, the "typical 10% buffer" seen with similar products would cause investors to lose 20%.

"The market has to go down significantly before that geared leverage catches up to your additional buffer," he said.

"On a comparative basis, this geared leverage is not as onerous as it seems."

Michael Kalscheur, financial adviser of Castle Wealth Advisors, said that he likes the structure of the product.

"The terms are very good," he said.

"You have leverage on the upside that is uncapped, which I really like. There is a very nice buffer of 20%. You have the downside gearing, and that's OK. Unless the index collapses, that's not terrible."

He compared the notes' buffer to another 20% buffer without the downside leverage factor.

With the notes, an index decline of 40% would generate a 25% loss. With the same buffer but with no downside leverage, the loss would be 20%.

"If the underlying is down 40%, you would outperform by 15% instead of 20%. It's not bad," he said.

Bailed out

However, Kalscheur had two objections to the notes: the issuer's creditworthiness and the underlying investment theme and index.

"Goldman Sachs as a credit is about as low as I would go," he said, adding that the issuer is rated A- by Standard & Poor's.

"A single A- is what I would consider the minimum to invest in. But it's not just about the rating per se.

"I am just a bit more suspicious about a Goldman Sachs than other banks.

"Just after 2008, Goldman Sachs was bailed out by Berkshire Hathaway. They wouldn't be here if it were not for Warren Buffett. There may not be a Warren Buffett next time.

"I know Wells Fargo, RBC, JPMorgan. I know what they do. I have a lot of confidence in these institutions. They have the lending side, they have retail, they have other things. I know they'll be around for a long time.

"Maybe Goldman Sachs is a great stock to buy, but as far as structured notes, they make me nervous regardless of what their rating is."

Kalscheur said that he likes the structure of the notes but not the underlying index.

"I like the buffer, the upside participation, the uncapped. But the issuer is not my favorite. And I'm also not completely comfortable with the index itself," he said.

The standard deviation of the Euro Stoxx is "much higher" than that of the S&P 500, he noted.

"The three-year standard deviation of the S&P is 12.4% versus 25% for the Euro Stoxx. On a five-year [term], it is 18.1% for the S&P and 29.6% for the Euro Stoxx," he said.

"It's much more volatile than the U.S. large-cap benchmark. That's probably because there are only 50 stocks in it. It's much more concentrated."

Kalscheur said that if he decided to get exposure to Europe, he would choose a much broader index, such as the MSCI EAFE index, which covers developed countries with a majority of its country weightings in Europe.

"Or I would choose a more specific index. I would take Germany," he said.

The type of security itself, a structured note, may not be best for this type of equity allocation, he said.

"Assuming that I was a big fan of the Euro Stoxx, I would choose an active manager to get that type of exposure, not a structured note," he said.

"Studies show that it's really hard to beat the S&P 500 with an active manager when you look at your net after fees, while beating the Euro Stoxx with an active manager is not as tough.

"There are more opportunities for active managers to add value to an international portfolio. That's what I would do rather than using these notes."

Relative performance

In terms of relative performance, Kalscheur said that U.S. stocks outperform the euro zone benchmark over longer periods of time.

"The Euro Stoxx has had some recent success relatively speaking, especially last year. Part of that is just timing," he said.

"If you look over longer periods of time, on a three-, five- or 10-year basis, the S&P 500 has done better."

Over the past three months, the Euro Stoxx has risen nearly 16% versus less than 3% for the S&P 500.

But in the last three years, the S&P 500 has gained 49% while the Euro Stoxx has moved up 6.5%.

The gap is wider over the last five years, during which the S&P 500 rose 76.5% versus 16% for the Euro Stoxx 50.

"This is one of those where I'm not sold on the index. I don't know why I would want to get exposure to this particular benchmark. I would rather have something much broader like the EAFE or very specific," he said.

"Since I'm not very comfortable with the issuer's credit, it's clear that I would take a pass on this particular offering."

Goldman Sachs & Co. is the underwriter.

The Cusip number is 38147QE28.

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