GS Finance’s $1.73 million leveraged notes on Euro Stoxx: big buffer sparks praise, criticism

By Emma Trincal

New York, June 26 – GS Finance Corp.’s $1.73 million of 0% leveraged buffered index-linked notes due June 28, 2023 tied to the Euro Stoxx 50 index provoked reactions among financial advisers surprised at the exceptionally big buffer size.

If the index return is positive, the payout at maturity will be par plus 200% of the index return, subject to a 95% cap. Investors will receive par if the index falls by up to 50% and lose 1% for every 1% decline in the index beyond 50%.

Incredible

“A 50% buffer? What’s not to like?” asked Carl Kunhardt, wealth adviser at Quest Capital Management.

“It’s a fantastic story.

“Leverage on the upside. A 12% cap on the upside...Who’s’ going to sneeze at 12%? A 50% buffer on the downside...That’s just incredible!

“I would love to get my hands on something like that.”

Kunhardt said he doubted Goldman Sachs would make the notes available to external clients.

Looking at the fee structure, he concluded that the notes were unlikely to have been sold to retail.

The underwriting discount includes a 0.375% fee, a structuring fee of 0.50% and a marketing fee of 0.75%.

“This may have been a private client or an institutional investor. The fee isn’t much.”

Credit

Kunhardt was not overly worried about the exposure to Goldman Sachs’ credit risk.

“Six years is long time. But the risk is reasonable,” he said.

“After Lehman Brothers everybody looked at credit risk. And you should. But Goldman weathered the 2008 crisis. You would really need a major financial disaster... Credit risk is a concern but nothing else,” he said.

Past returns

While a 50% buffer seemed like a lot, Kunhardt said, “you never know.

“When you look at performance over the past 50 years, it seems like you don’t need it. But in that period, you had stocks going up as a result of central banks manipulating the markets,” he said.

“Just as often as not, when the government starts manipulating the system, they just start creating a mess. So we really don’t know what kind of returns we’ll have in six years. The last 10 have had a big weight.”

Kunhardt said that from a marketing standpoint, the notes were very attractive.

“You tell a client about the 50% buffer. They ask you: What does that mean? It means that if the market is down 50% you don’t lose anything. Okay. Sign me up!

“This is a very, very attractive note.”

Buffer

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, held the opposite view.

“This is one of the poorest examples of any notes I’ve seen in a long time,” Foldes said.

The six-year tenor was for him a “non-starter.” But he expanded his criticism beyond that.

“I think it takes a lot of nerve to put a 50% buffer on a six-year. They’re selling you something that’s illusory,” he said.

“For any asset class to be down 50% over six years is highly, highly unlikely.”

Upside, dividends

The expensive buffer had an impact on the potential return by reducing it, he added.

“When you’re talking about six years you want plenty of upside. This is just above the historical return for this asset class,” he said.

The 95% cap over the six-year term represents an 11.77% annualized return on a compounded basis.

Another issue was the non-payment of dividends, which represents a bigger problem when the underlying index pays a high dividend yield. This is exactly the case with the Euro Stoxx 50 index, which yields 2.86%, or one percentage point more than the S&P 500 index.

“They’re taking more than 18% when you annualize it.”

Capping value

Finally the notes deprived investors of a significant value proposition, he said.

Since the financial crisis, the Euro Stoxx 50 index has been underperforming the S&P 500 index.

Over the past 10 years, the U.S. benchmark has gained more than 62%. The Euro Stoxx 50 has seen its value drop 35% during the same time. The comparative chart is evolving however. This year the European benchmark has outperformed the S&P 500 index as it is up 16% versus 9% for the S&P.

“They’re giving you a buffer that’s illusory for that length of time and you’re talking about an index, which, unlike the S&P is below its historical norm,” he said.

“Why would I want to buy something that’s historically cheap and not get fair value for it?

“And why would I want a cap that low for such a long-term note?

“I would be doing my client a great disservice by doing something like this.”

Goldman, Sachs & Co. is the underwriter.

The notes are guaranteed by Goldman Sachs Group, Inc.

The Cusip is: 40054LGC2.

The notes priced on June 21.

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