Goldman's leveraged notes with cap tied to Euro Stoxx 50 offer growth potential for mild bulls

By Emma Trincal

New York, May 31 - Goldman Sachs Group, Inc.'s upcoming 0% leveraged notes linked to the Euro Stoxx 50 index offer enhanced growth to investors who are sufficiently bullish to tolerate full downside exposure but not overly bullish as a cap will limit their gains on the upside, said Eve Berlinska, structured products analyst at Future Value Consultants.

The notes will mature between 24 and 27 months after pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus double any index gain, up to a maximum return of 46% to 54%. Investors will share in any losses.

"This is a two-year leveraged return product, which will perform best in a moderate growth scenario because of the cap," she said.

"The notes are designed for investors who want exposure to the Euro Stoxx index without having to invest in the index directly.

"We've assumed a 52% cap, which is 75% within the range, based on our methodology.

"We also picked a two-year hypothetical term. It's based on our methodology. We will take the lower end of the range.

"A 52% return over two years would be the equivalent of a 26% index performance over that period, since you get two times that. That's 13% per year."

The index is up 5% for the year and 31% for the past 12 months.

Moderately bullish on Europe

"It's bullish, but not excessively bullish since you're not getting any return above the cap," she added.

"At the same time, the investor needs to be bullish enough to believe that the index won't decline. Any decrease in the index price at maturity will cause the investor to lose money by the same percentage. Investors could lose their entire principal."

The notes offer a specific return profile distinct from a long position in the index and also different from other similar products, she said.

"On the plus side, the notes give you the opportunity of getting a high return as a result of the leverage. You can certainly outperform the index on the upside," she said.

"The less appealing features are the cap, since you're not going to participate in anything above it, and the fact that the entire principal is at risk.

"There is another negative aspect in terms of unpaid dividends. While foregoing dividends is the norm with structured notes, the Euro Stoxx index happens to pay a lot of dividends with a 3.75% yield. That's a high opportunity cost compared to, for instance, the S&P at 1.95%. In order to attract investors, the issuer has to offer better terms because when investors do not get the dividends on this index, they're foregoing quite a bit."

Future Value Consultants in its research assesses risk, return and price using a variety of proprietary scores in order to compare a product with others.

The research firm compares each product with two different averages: "same product type" and "all products" recently issued.

In this report, the "same product type" represents all leveraged notes, with or without downside protection, capped or uncapped.

Based on the report, the Goldman Sachs leveraged notes linked to the Euro Stoxx show a higher level of risk, but the return potential is also greater than average, which will give the product a good return score, she said.

Higher risk

"The higher risk is due to both credit and market risk. But it's mostly the market risk that contributes to the elevated risk," she said.

Future Value Consultants rates 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 have a 0.78 credit riskmap, compared with 0.66 for the average score for products of the same type.

"The credit risk is higher because of the longer term of the notes compared to the average leveraged return product, which typically has a one-year to 18-month maturity," she noted.

"The two-year credit default swap for Goldman Sachs is about average. So it's the term that matters here rather than issuer's credit."

The market riskmap for the notes is 4.14 versus 2.77 for the same product type.

"The market risk is higher than average for this type of product because there is no protection. A lot of leveraged return products have either a buffer or a barrier. This one does not," she said.

"The volatility may also be part of it. At 20%, the implied volatility is higher than the volatility of the S&P, which is at 16%."

The riskmap of 4.92 is higher than 3.44, the average riskmap for leveraged products.

"Most of this product's higher riskmap is due to the market risk. Your downside is similar to a tracker fund."

Return, price

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets 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.

Compared to 7.46, which is the average return score for the product type, the notes show a better score of 8.10.

The return score is even better than the average of all products, which is 6.58.

"For the given risk, the return is good in comparison to what is offered in the same product category. It's probably the cap level that contributes to this result, as it is relatively high," Berlinska said.

Price score

Future Value Consultants measures a note's value to the investor on a scale of zero to 10 via its price score. The product's price score is 8.01, compared with 7.62 for the average of its peers. 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 issuer spent more on the options than average. Of course, this score is subject to change given that we have two variable terms: the cap and the maturity. We chose the shorter maturity of 24 months for our model, but it could be 27 months. Also, the cap could be on the lower end at 46%. Both variables could change the price score quite a bit," she said.

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

The average overall score for leveraged notes is 7.54. The product has a higher score of 8.05. The notes' score is even better than the overall market. The average overall score for all products is 6.58.

"It's a pretty good overall score. But it's not surprising given that we have a price score and a return score that are both above average," she said.

Leveraged products tend to score well compared to other types of structures, she said.

The average overall score is 7.54 for leveraged return notes versus 6.79 for autocallables and 5.65 for reverse convertibles.

"This product is for bullish investors who obviously expect the index to grow. They also have to be willing to give up protection and dividends. It is not designed for the skittish, more risk-averse type of investor," she said.

Goldman Sachs & Co. is the underwriter.

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