Goldman's trigger notes tied to S&P 500 may appeal to investors targeting minimum return

By Emma Trincal

New York, Nov. 16 - Goldman Sachs Group, Inc.'s 0% index-linked trigger notes due Dec. 4, 2013 linked to the S&P 500 index are designed for investors looking for a minimum return and some downside protection, said Suzi Hampson, structured products analyst at Future Value Consultants.

A trigger event occurs if the index level falls by more than 20% on any day during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

If a trigger event occurs, the payout at maturity will be par plus the index return, which could be positive or negative.

If a trigger event does not occur, the payout at maturity will be par plus the greater of the index return subject to a cap of 15% and the contingent minimum return of 6.1%.

"The calculation is that the S&P [500] is not going to fall by more than 20% any time during the year. If they're right, investors get the 6.1% minimum return. This strategy would appeal to investors or investment managers who have a target return for their portfolio," Hampson said.

"Another appeal is the possibility of outperforming the S&P 500 in a range bound market. If the benchmark closes anywhere between 80% and 106% of the initial price without ever hitting the 80% threshold, investors will outperform the market and get the 106% return.

"The notes finally represent an alternate way to get exposure to the U.S. equity markets by changing drastically the risk return profile of a direct investment in the S&P 500 index.

"People considering buying those notes want to lower the risk of their investment. And so they are prepared to have a limited upside. The 15% cap is the trade off. That's how you can get the downside protection," she said.

Bonus

Future Value Consultants categorizes these types of structure as bonus notes, the word bonus designating the minimum payment.

A bonus product is a capital at risk note with a minimum payment payable as long as a barrier is not hit, explained Hampson.

The barrier can be monitored any day (American style) or at maturity only (European style), she added.

"In this case, we have an American-style barrier, which is less attractive. You're better off when the barrier is observed only at the end, obviously," she said.

"Unlike a reverse convertible or an autocallable, this structure gives investors some participation in the upside when the performance exceeds the bonus. While the upside participation is capped in order to finance the downside protection, you can still get growth above the minimum return.

"It's also very similar to an autocallable except for a couple of things. First, like with the reverse convertible, you don't have the participation when you invest in an autocallable.

"Second the barrier component is different. With the autocallable, the barrier is observed only during the observation dates, for instance quarterly and at maturity but the barrier level is more risky - usually it's at the initial price level. With the bonus structure, the barrier is typically monitored thorough the life of the notes but the good part is that it's often set below the initial level.

"One has a barrier that can be hit more easily but that's monitored only a limited number of times; the other has a more protective barrier but one that can be breached any time," she said.

Views

Because investors get many hybrid features and can play a variety of market views, bonus products are not necessarily straightforward, she said.

For instance, investors may seek income or growth strategies or both when investing in these products as well as a wide range of downside cushions, she said. The protection is contingent only and can be observed in different ways.

Some investors may use the instruments to express a moderately bullish view, or even a more bullish view depending on the cap. Finally, the product can be used as an alternative to a direct long-only equity investment as it modifies the risk-reward trade-off, she said.

"I think it may be a complicated idea for the simple investor. It would certainly be expensive to put this together with options because it has quite a few components," she said.

As a result, investors need to pay attention to the type of downside protection offered and the conditions required to get the bonus, she said.

"The important thing for investors to understand is that the downside protection is only conditional. It's not a given, like a buffer. Once the barrier is breached it goes away, as well as the right to get the minimum return. They also need to realize that the barrier can be breached throughout the life of the product. One time is enough," she said.

"As far as having a market view, I don't think most people would buy it because they are betting the market will trade sideways. I think it's more of a cautious bullish strategy for people who need to limit the downside risk and want to get something if the market does not perform too well or if it's down within a range," she said.

"They agree to the cap to get the protection. Ideally, they want to finish above 6.1%. But obviously, if the index is lower and even negative by less than 20%, they'll still be quite happy with 6.1%," she said.

Risk, scores

Future Value Consultants measures the risk associated with a product on a scale of zero to 10 with the riskmap, which is the sum of two risk components - market risk and credit risk.

The higher the riskmap is, the higher the risk of the product.

The research firm scored the notes in comparison with the average score of the same product type, in this case, other bonus structures.

At 3.2, the notes' riskmap is lower than 3.62 for the same product type.

The difference, she said, was mainly due to a lower market riskmap of 2.35 in comparison with 2.82 for the bonus structure average.

"It could be that the barrier is lower or that other products are tied to riskier underlying assets. If volatility has gone down recently, the product could have also become less risky," she said.

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions - neutral assumption, high and low growth environments, 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, which in this case is low volatility.

At 7, the return score is exactly the same as the average of the same product type.

The same is true for two other scores - the price score and the overall score.

The price score is Future Value Consultants' measure of the value of a product on a scale of zero to 10. The higher the score is, the better the value and the lower the fees taken per annum.

The price score of 7.78 is just nearly identical to 7.80 recorded for the same product type.

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

Since the difference of return and price scores with their peers in the same product type category is almost negligeable, the 7.39 overall score of this product is nearly the same as the 7.40 average for all bonus notes recently rated by Future Value Consultants.

"This is a product for investors targeting a fixed return even though it's not a guarantee. All the main scores - return, price and overall are very similar to what we have in this type of product. There's not much difference. This is a product that's just average," she said.

Goldman Sachs & Co. is the underwriter, and J.P. Morgan Securities LLC is the placement agent.

The notes (Cusip: 38141GJC9) are expected to settle on Nov. 21.

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