GS Finance’s eight-year notes tied to Dow Jones offer good trade-off for long-term play

By Emma Trincal

New York, Jan. 6 – GS Finance Corp.’s 0% notes due Jan. 30, 2025 linked to the Dow Jones industrial average offer a “different proposition” for long-term investors seeking full downside protection, said Tim Mortimer, managing director at Future Value Consultants.

If the index return is positive, the payout at maturity will be par plus the index return, subject to a cap of 90% to 100% whose exact level will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the index return is zero or negative, the payout will be par.

Dow Jones

“It’s a bit different. First we don’t see many principal-protected notes anymore. And this product is on the Dow Jones. The S&P 500 is so dominant. This underlying index brings some diversification away from the S&P,” Mortimer said.

The Dow Jones has gained 11.50% since the U.S. presidential elections while the S&P 500 index is up 8.95%.

“The Dow has outperformed the S&P over the past couple of months but that’s probably not why people would buy the notes,” he noted.

“The difference in volatility is not significant either. The Dow has a little higher yield but it’s not significant enough to make a difference even over eight years.”

The Dow Jones and the S&P 500 index yield 2.32% and 2% respectively.

“The best explanation is that investors don’t want to be overexposed to the S&P.”

Cap, tenor

Even for a principal-protected note, the issuer is showing a longer-dated investment with an eight-year maturity, Mortimer said.

The lack of upside leverage over such a long period of time is due to the competitive cap level, he said.

“You could have introduced some leverage. But you would have had to reduce the cap for that. And this is a good cap,” he said.

At the lower end of the range, a 90% maximum return would give investors 8.3% in annualized compounded return.

“That’s a pretty good return. Most people would be happy with that,” he said.

“If including leverage led [the bank] to reduce the cap to 70% or 80%, it would be much less attractive.”

In general, investors do not want to “tie their money” for too long, he said. A 10-year product would be difficult to sell. But a five or six-year note may not be compelling enough.

“The long duration is the tradeoff for this high cap and capital guarantee,” he added.

Risk

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others. The comparison for this product was limited to all product types as the number of fully principal-protected notes is insufficient in the market to score the category itself at this point, Mortimer explained.

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 being the highest level of risk possible.

The notes have a 0.85 market riskmap versus an average of 2.63 for all products, according to Future Value Consultants’ research report.

The low market risk score was due to the absence of exposure to a market downturn, he said.

On the other hand, the 1.15 credit riskmap, higher than the average of 0.38, was a direct result of the long maturity.

Adding the two components gives a riskmap of 2 versus 3.01 for the overall average.

Price

For each product, Future Value 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.

At 9.75, the price score is much higher than the average, which is 7.07.

“It’s quite a simple product. You get one for one with the index, no downside risk and the chance of doubling up. It’s priced competitively,” he said.

Another factor for the high pricing score was the tenor.

“It also prices very well due to the cost on a per annum basis. It’s spread out more than most products because it is longer than most products.”

Risk-adjusted return

The return score measures the risk-adjusted return of a note.

The notes show an 8.34 return score compared to 6.53 for the average.

“The product offers the opportunity to go up to 90%. You get a long time horizon to compound return and there is quite a high cap,” he said.

Also helpful was the low market risk.

“There is no bad outcome to counteract the attractive upside potential. There is no risk of suffering a bad market, which is quite a good tradeoff.”

Overall

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 product scores a 9.05 overall versus 6.80 for the average of all products.

“As with any other investment, you have to be happy with the maturity and the underlying asset,” he said.

“But for someone looking for long-term U.S. exposure with a higher cap and full downside protection, this note can offer a compelling trade,” he said.

Goldman Sachs & Co. is the agent.

The notes will be guaranteed by Goldman Sachs Group, Inc.

The notes will price on Jan. 25 and settle on Jan. 30.

The Cusip number is 40054KSN7.

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