Goldman's buffered digital notes linked to S&P 500 aimed at investors with low growth outlook

By Emma Trincal

New York, Sept. 16 - Goldman Sachs Group, Inc.'s 0% buffered equity index-linked notes linked to the S&P 500 index are for neutral investors with a slight bearish bias, said Gurdeep Ubhi, structured products analyst at Future Value Consultants.

The notes are expected to mature between 13 and 15 months after issue, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls by up to 20%, the payout at maturity will be par plus the digital coupon, which will be between 7.75% and 9%. The exact amount will be set at pricing.

Investors will lose 1.25% for each 1% that the index declines beyond 20%.

"This is for investors who expect a moderate or even slightly negative market performance," said Ubhi.

"You still get a 7.75% coupon if the index falls by less than 20%.

"What you want in 13 months is an index that doesn't fall by more than 20% and doesn't grow by more than 7.75%."

Digital

These structures, called digital coupon notes in the United States and "defensive digital" in the United Kingdom, are usually short-term products, said Ubhi.

They offer a fixed coupon if the underlying closes above a predefined threshold.

"We're seeing more and more of those because the digital structure allows you to get paid even if the index is negative. You can outperform the underlying benchmark that way," said Ubhi.

"Digital notes were the second most popular payout types last month after leverage in terms of notional [amount] being issued," he said.

Lower risk

One of the characteristics of these Goldman Sachs notes is their relatively low level of risk, he said.

The riskmap for this product is only 3.04. Riskmap is a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10.

The riskmap compares the average product underperformance (relative to cash) with the average underperformance of five sample assets of different volatility levels. The risk rating equates the risk of the products against the five hypothetical assets.

The research firm compares the product's riskmap with that of the average of all similar products. In this case, the "similar products" category includes all other digital notes of various maturities and protection types, whether offered in the form of a barrier or buffer.

The average riskmap for similar products is higher at 4.24.

"We have something less risky than other digital products because of the buffer," said Ubhi.

"A buffer is less risky. It's more valuable to the investor than a final-day barrier or an intraday barrier because once the barrier is breached, you are fully exposed to any loss in the index."

Buffer value

With this product, investors lose money at a rate of 1.25% for 1% decline in the S&P 500 beyond the buffer amount, which is worse than the usual one-for-one loss, he noted.

Yet, the buffer still provides more protection.

"The downside gearing can take you down to zero, but you still outperform the index."

As an example, Ubhi compared the product with a hypothetical one offering a 20% final-day barrier. If the index was to finish down 25%, the hypothetical product would generate a loss of 25% for the investor. But the investor in the Goldman Sachs notes would only lose 6.25% of his principal, or 5% multiplied by the leverage factor of 1.25.

The buffer also helps reduce the market riskmap, which is, with the credit riskmap, one of the components of the riskmap score. Both component scores are also measured on the zero-to-10 scale.

The market riskmap for the product is 2.51, compared with 3.43 for similar structures.

"You have the buffer and also the fact that it's relatively short term," said Ubhi.

Return score

Future Value Consultants' opinion of the risk-adjusted return is expressed with the return score on a scale of zero to 10.

While the risk is limited, returns are also subdued in this structure, explained Ubhi.

"This is for the slightly bearish, neutral investor. It offers a lower return because you're taking less risk," he said.

The 6.50 return score for those notes compares less favorably than the score for similar digital deals, which is 7.29.

"I think it's because some other digitals offer you a chance to grow above the coupon provided that the index reaches a certain threshold. This one doesn't," he said.

The return score is also slightly less than the 6.04 score for all products.

The "all products category" includes structures as diverse as reverse convertibles and leveraged notes for instance.

"For a product to offer a higher return score, you'd have to take more risk," said Ubhi.

"You're limited to what you can get. Yes, you can have a coupon even if the index is negative. But you are capped to the digital amount. You can't go above that, which is why your return score is not as high as what it could be with another product."

The return score derives from the probability of return outcomes calculated by Future Value Consultants using a Monte Carlo simulation and displayed in a chart across different return buckets.

The probability table associated with this product shows a distribution of probabilities between losses and gains of a quarter and three-quarters, respectively.

Investors have a 76% chance of making money; however, the entire probability is concentrated in the 5% to 10% gains bucket, and there is no chance of generating any return per annum higher than that.

Price, overall

Future Value Consultants' estimates the total costs taken out of the product from direct fees and profit margin on the underlying derivative with its price score.

The notes have a high price score of 9.61, which is more than other digital types of products (8.02) and even more than all other products (5.52).

"Investors gain value with the products, which is why the price score is high," said Ubhi.

"However, they haven't fixed the terms yet. Depending on the tenor and the coupon, the price score could go up or down."

Future Value Consultants offers its opinion on the quality of a deal with its overall score, the average of the price score and the return score on the zero-to-10 scale.

The notes received an overall score of 8.05.

The score is better than 7.65, the overall for all similar products. It is also much higher than all products, which have a 5.78 overall score.

"The price score indicates value for money," said Ubhi.

"And despite a return score lower than similar products, the overall indicates that it's a decent product."

Goldman Sachs & Co. is the underwriter.

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