Goldman Sachs' capped notes linked to S&P 500, Russell 2000 with 40% buffer target bears

By Emma Trincal

New York, July 14 - Goldman Sachs Group, Inc.'s 0% buffered basket-linked notes linked to two U.S. equity benchmarks are for bearish investors whose primary goal is to protect themselves against a possible market decline but who still want to capture some of the upside, sources said.

The basket consists of the S&P 500 index with a 70% weight and the Russell 2000 index with a 30% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The maturity date is expected to be between 29 and 34 months after issue.

The most unusual characteristic of the deal is its large buffer: Investors will receive par if the basket falls by up to 40%.

However, investors may lose their entire principal because each 1% decline of the basket beyond the 40% buffer will translate into a 1.6667% loss of capital, according to the prospectus.

Investors will participate in any basket gain, up to a 14% to 16.5% cap point to point.

True bears

"This is for someone who says 'I don't believe the market is going to do very well, but in case it does, let me pick [up] a little return,'" said Steve Doucette, financial adviser at Proctor Financial.

"It's a note for the true bear who thinks he may be wrong."

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he hasn't seen many buffers of that size recently.

"It's a good buffer. And it's a bearish buffer," he said.

"This note is for people who are moderately bullish but who, more than anything else, are very, very sensitive to protecting their downside."

Market pessimism

Medeiros said that structures that offer such a generous protection may gain traction in today's market as investors have turned more cautious.

"We're more optimistic, but this fits into the current mood in the market. The overall sentiment right now is more pessimistic," he said.

"This product offers a way to get into the market with some of the upside and a very attractive principal protection.

"Investors right now want some of the upside participation, but they want to avoid the downside. That's what they're buying right now.

"If you ask any high-net-worth client, he would tell you 'I'm looking for modest returns, and I want above all to protect my principal.'"

Doucette said that he likes the underlying basket and that it is overweight large-cap stocks.

"I like it. Two years out of an economic recession, even though we're still probably in it, and you'll see large caps taking over," he said.

Cost of protection

Doucette said he would not use the notes, though, because they cost too much in upside for a protection that may turn out to be unnecessary.

The cap limits investors' returns per annum at about 5% to 7% depending on the maximum return and tenor, which will be set at pricing. This limitation is what gives investors the above-average protection.

"I'm not a real bear," Doucette said.

"I do think that the market could go down after a two-, three-year bull run.

"But this is almost three years. What if the market continues to deliver solid gains? You would be giving up returns with this huge buffer. It's too soon to be a bear."

Solid protection

Despite the prospectus warning investors that they could lose their entire principal, Doucette said that the protection was likely to be sufficient.

"I'm not too concerned with what's happening once you go down beyond the buffer," he said.

Doucette doesn't believe the market will decline enough for investors to suffer a 100% loss. "And if that's the case, we'll have other things to worry about."

Medeiros agreed that if the main purpose of the notes is to deliver as much protection as possible with a modest return, the notes achieve this goal.

"I think it's a safe buffer," he said.

"When I look at the S&P 500 and the Russell 2000, the earnings have made progress; the balance sheets have improved substantially for those companies. It's a completely different situation than in 2008 when we had high leverage and high P/Es," he said.

Goldman Sachs & Co. is the underwriter.

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