GS Finance’s notes on index basket’s weighted return put allocation on autopilot

By Emma Trincal

New York, Sept. 15 – GS Finance Corp. plans to price 0% basket-linked notes due Oct. 5, 2027 linked to the return of a weighted basket comprised of the S&P 500 index, the MSCI EAFE index and the MSCI Emerging Markets index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus the weighted return of the basket.

The weighted return will be calculated on the determination date, Sept. 20, 2027 as follows: the best performing of the indexes will be given a 65% weight, the index with the second-best performance will be weighted at 35% and the lowest-performing index will not count toward the basket performance.

“It will be interesting to see what happens next month after the Fed raises rates,” said Steve Doucette, financial adviser at Proctor Financial.

The Federal Open Market Committee meeting will be held on Sept. 21. The notes will price on Sept. 30, according to the prospectus.

“We’ll see if we get a good entry price. Who knows what happens in one week?”

Avoiding errors

Doucette has invested in similar notes before and said he likes the concept.

“We’ve been doing asset allocation for years and you can’t avoid making some mistakes,” he said.

“I like this note because you don’t have to make the asset allocation decision. The note does it for you and it optimizes the return. You have no exposure to the worst index and close to two-thirds allocated to the best-performing one.”

Doucette says he mitigates risk in general by not investing more than 10% of his portfolio in structured notes.

But even within the limited bucket, errors can be costly.

“Suppose I pick a 7% allocation to emerging markets and they underperform. With the note, I have zero exposure,” he said.

“Or let’s say emerging markets are through the roof. I only have a 7% allocation. The note will maximize my allocation boosting it to 65%.

“The note puts the allocation on autopilot, doing it better than you would.

“It gives you the ability to be right without the downside risk of being wrong.”

Best-of, sort of

The notes bring to mind an “inverse worst-of,” he said.

“Theoretically, you could call it a best-of.

“The difference is that you’re not getting 100% of the best performing one, only the highest weight and it decreases gradually as the performance gets worse. This one is interesting because you get zero exposure to the worst index. I’ve seen some with a 10% or 15% allocation to the laggard.”

If the market is down, the index with the 65% weight may still be negative, he noted.

“But if you compare your own allocation to this you’re still outperforming with the notes.”

The five-year tenor was “a bit long” but offered some advantages.

“Five years from now, would any of these indices be negative from today? I think the chances are pretty slim,” he said.

The longer duration helped mitigate the downside risk, which matters given the absence of any downside protection, he added. The other mitigating factor was the weighted basket itself.

“I like those notes. You capture the best of the three.”

Speculative

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he would not consider the notes for his core portfolio.

“I don’t think I’m interested in this one. The reason I would do a structured note is to have some sort of protection. Here we have none,” he said.

Positioning the note in the portfolio would be challenging given that the final allocation is only determined and known at maturity.

“I wouldn’t know which portion of my portfolio I would allocate this to,” he said.

One exception would be to put the note in his “risk bucket,” which consists of speculative assets, he said.

“If I did it, I would put it there and I would use it as very small percentage of my portfolio,” he said.

The notes in his view complicate rather than facilitate the work of an asset allocator.

“All you know is the names of the three indices. You don’t know how it’s going to fit in the portfolio because you won’t find out what your basket looks like until five years from now.

“It’s as if you were car shopping and there’s a great deal on the Mercedes but you really wanted to buy a pickup. Are you going to buy the Mercedes? It doesn’t make sense.

“The main question I have here is: where does it fit?”

One positive aspect of the deal however was the maturity.

“Five years is decent. It gives you pretty much a full market cycle.

“Most notes coming out now have a price advantage because of the decline in the market already. We could have more declines of course, but you’re already getting in at a nice level.

“That aspect of the deal is OK,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes will settle on Oct. 5.

The Cusip number is 40057N4Y0.

© 2015 Prospect News.
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