Goldman Sachs’ notes linked to Euro Stoxx 50 offer short tenor, 2x leverage but no protection

By Emma Trincal

New York, Aug. 28 – Goldman Sachs Group, Inc. is readying a short-term leveraged note with a reasonably attractive cap, sources said, but in exchange, investors have to bear the full downside risk.

The trade-off – no protection in exchange for a shorter duration – has become increasingly common as firms struggle to offer attractive return enhancement features without extending terms excessively, a buysider said.

Goldman plans to price 0% leveraged notes due Sept. 16, 2015 linked to the Euro Stoxx 50 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is positive, the payout at maturity will be par plus double the index gain, subject to a 20.7% cap. Investors will be fully exposed to any index decline.

Short is tough

The buysider explained that pricing is challenging for short-term notes, which leads banks to force investors to choose between protection and short duration.

“It has become very competitive for firms to build these one-year notes, especially with a buffer. Here they’re just trying to give you as much upside as they can capture,” the buysider said.

The choice of the underlier also reflects pricing constraints.

“A lot of those notes aren’t U.S.-based because volatility in the U.S. market has been incredibly low. Issuers have to go to foreign indices or get more exotic assets in order to create these terms,” he said.

“Issuers have a tough time competing with the options markets in general. If you want that type of payout, you can use notes or you can put an option trade directly. For many investors, using options themselves has become the best alternative. It’s more liquid, and you can go short-term while a lot of the notes are three to five years – that’s the funding range banks use the most. The bond component of the notes has to be in that three- to five-year range in order for the banks to make the notes more attractive. No bank is looking to raise money for one year.”

Bullish call

The absence of any downside protection gives the issuer more leeway in making the deal both shorter and appealing on the upside, he said.

“It’s pretty straightforward. They’ve structured this note in a very simple way, with no buffer or barrier. They just capped the upside and sold a call. That’s all there is to it,” he said.

“For someone who is bullish on European stocks and wants exposure to this market, getting twice the upside with a 20.7% cap isn’t bad, especially considering that Europe hasn’t rallied that much. The recent comments from Draghi showing that the European Central Bank is turning more accomodative are likely to boost the European market.”

The leverage component of the notes may be helpful if the European economic recovery failed to materialize quickly, he noted.

“Some countries within the euro zone represent greater risks. France for instance is a train wreck. It almost has to get better at some point. You can see the turnaround story,” he said.

“That’s why if some countries continue to be a drag on European growth, the leverage can really help you outperform the index.”

Your view, your note

Steve Doucette, financial adviser with Proctor Financial, said the notes are a good fit for bullish investors unconcerned with the downside risk.

“It’s a nice short and sweet note if you think the market is going to go up. From zero to 10% in growth, you double up. That’s a pretty attractive cap. If that’s your view, that’s the note,” he said.

But Doucette said he would be concerned with the risk of a short-term correction given that the current bull market is already more than five years old.

“You have to think about the market cycles. If there’s a pullback, you’re long the index,” he said.

Doucette said that some notes are designed for protection while others are more geared to enhance returns, sometimes leaving investors to decide between being defensive or aggressive.

“This one gives you the advantage on the upside, not on the downside,” he said.

“I’m always trying to do both no matter where the market moves.

“We just did a note on the Euro Stoxx. We went the barrier route. Buffers are so expensive.

“We don’t know where the market will be a year from now. You want a little bit of protection built in there. If you get some leverage on top of it, that’s great.

“With this note, if the market is up by less than 10%, you outperform; if there’s a pullback, you’re long the index. If you’re not interested in protection, that’s the right note.”

Protection, liquidity

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he would not consider the notes despite their short duration because of the full exposure to market risk.

“I’m not comfortable with the notes because they don’t offer any downside protection. If I give up liquidity, I would prefer to have some buffer or barrier,” he said.

“If I wanted to get the leveraged exposure, I would look at a leveraged ETF on the Euro Stoxx or I would consider options. But I guess this note, unlike an ETF, only leverages the upside, and that’s a plus.

“The notes give you one-to-one on the downside as opposed to two-to-one with an ETF. Still, I don’t really see the advantage of being locked in a note for one year, even if it’s just one year. Liquidity is liquidity.”

Selective picks

In addition, Medeiros said that he would tend to avoid a broad index, such as the Euro Stoxx 50 index, if he wanted to allocate to European stocks.

“I’m mildly bullish on Europe. But when I look at Europe now, I try to narrow my focus in order to find country-specific opportunities,” he said.

“I like France, Germany, but I don’t like Italy, I don’t like Greece. Britain is probably the best. So if I get exposure to Europe, I’m going to pick the top three countries, Germany, the U.K. and France. I would do an equal weighting amongst these three and probably as opposed to a broad benchmark.”

Goldman Sachs & Co. is the underwriter.

The notes were expected to price Friday and settle Thursday.

The Cusip number is 38147QFC5.

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