GS Finance’s leveraged buffered notes linked to Russell 2000 are designed to outperform market

By Emma Trincal

New York, July 1 – GS Finance Corp.’s 14-month 0% leveraged buffered notes linked to the Russell 2000 index offer investors two out of three scenarios to outperform the underlying benchmark, said Tim Mortimer, managing director at Future Value Consultants.

The notes are guaranteed by Goldman Sachs Group, Inc., according to a 424B2 filing with the Securities and Exchange Commission.

If the U.S. small-cap benchmark index finishes positive, the payout at maturity will be par plus 1.5 times the index return, subject to a maximum settlement amount of $1,147 for every $1,000 principal amount of notes. Investors will receive par if the index declines by 10% or less and will lose 1% for every 1% that the index declines beyond the 10% buffer.

Widespread structure

“In the U.S. market, buffered leveraged return notes are an extremely popular product and always have been,” Mortimer said.

“It provides better than the index performance in the event of a modest market growth.

“As long as the index is up 8%, you get your return of 14.5%.”

The accelerated return offers a potential return of par plus 14.7% over the 14-month term. On an annualized compounded basis, investors can earn up to 12.45% if the index rises by 8.32%.

“Most investors would say 8% a year is ambitious, but that’s to get you to the cap. You outperform the index on the upside anywhere up to 8%.”

On the downside, investors are certain to do better than the index because of the 10% buffer.

“The buffer helps you all the way down,” he said.

“The downside is even better because you’re going to outperform no matter what.”

Outperformance

Investors in the notes would benefit in most cases, he continued.

“There are two zones where you can win. You win in a modest growth market environment because of the leverage, and you win on the downside because of the buffer.

“The only time you don’t win is in a strong uptrend. You don’t lose though ... it’s more of a loss on a relative basis.

“Worst case, you hit the cap. But you still walk away with 14%.

“This is why those products are very popular: you get two wins out of three.”

Risk

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others, including its peers and all products recently rated by the research firm.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 1.75 market riskmap versus an average of 3.84 for the same product type, according to Future Value Consultants’ research report.

“It’s got quite a low market risk, and this is due to the 10% buffer. The Russell is slightly more volatile than the S&P, but the buffer more than offsets the volatility factor,” he said.

The notes compete with other products that may have no downside protection. Others may have a barrier, which is a less efficient protection in some cases.

“A buffer still helps you when you get through it. A barrier doesn’t,” he said.

The credit riskmap is 0.46, in line with the 0.41 average for leveraged return notes.

“The credit risk isn’t much. If the issuer had tighter [credit default swap spreads], it would have made a difference since it’s a short-term note. But it’s pretty close to the average,” he said.

By adding the two risk components, the model generates a riskmap of 2.21.

“It’s pretty low risk,” he said, comparing the score with the average of 4.25 for similar products and 3.13 for all products.

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor. Because of this calculation mode, longer-dated products usually score better on the price scale as there is more time for the cost to be spread over the life of the product.

At 8.76, the price score is higher than the 7.55 average for the same product type.

“The Russell is pretty liquid. The structure is very straightforward, very transparent. You tend to get products that are better priced when they’re simple products,” he said.

This high price score was obtained despite the disadvantageous short tenor.

“This indicates that it’s been priced very aggressively,” he said.

Return, overall scores

The return score measures the risk-adjusted return of a note. It is computed based on the best among five market scenarios. In this case, the score derives from a bullish market assumption.

The return score is 7.45 versus an average of 7.42 for similar products and 6.77 for all products, the report showed.

The low riskmap should have “helped” the return score. In this case, however, the score ends up being only average for two reasons: the underlying market assumption of the model and the short tenor, he explained.

“The calculation of the return score is based on the optimal scenario ... in this case a bull market. The short term of the notes ... it’s only 14-month ... is not helpful. When the market goes up, a three- to five-year note has more time to compound gains, which results in a better return score. We don’t have that here, which is why the return score is not much higher.”

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an overall score of 8.11 versus 7.48 for the average leveraged return note and 6.72 for all products.

“This is a tried and tested product on a popular structure, and it scores well,” he said.

Goldman Sachs & Co. is the agent.

The Cusip number is 40054KEH5.

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