Goldman Sachs’ CDs with averaging tied to three indexes offer equity exposure, minimum return

By Emma Trincal

New York, Feb. 9 – Goldman Sachs Bank USA’s 0% equity index-linked certificates of deposit due March 1, 2022 linked to a basket of indexes give conservative investors a chance to outperform Treasury and traditional CDs with equity-like returns while minimizing risk through principal protection, sources said.

The basket includes the S&P 500 index with a 50% weight, the Russell 2000 index with a 25% weight and the S&P MidCap 400 index with a 25% weight, according to a term sheet.

The final basket level will be the average of its level on each of the semiannual averaging dates, which are expected to be the 24th day of each February and August beginning Aug. 24, 2015.

The payout at maturity will be par plus the greater of (a) 50% of the basket return and (b) the minimum return, which is expected to be 8.5% to 9.5% and will be set at pricing.

Large-cap

Carl Kunhardt, wealth adviser at Quest Capital Management, said he liked the underlying basket.

“It’s a play on U.S. stocks. You have to be positive on U.S. equity over the next seven years. It’s predominantly a large-cap weighted bogey,” he said, commenting on the weightings.

“The mid- cap will move a lot like the S&P. Mid-caps are the bridge between small-cap and large-cap. They are behaving more and more like large-cap. The small-cap allocation with the Russell is a bit high.”

The averaging calculation for the final return was an important detail in his view.

“The averaging is pretty common. In my experience it’s a feature that tends to mute the return.

“I would prefer it point-to-point.

“At the same time what mutes the return is what also mutes the volatility.”

He picked a hypothetical minimum return at the mid-point of the 8.5% to 9.5% range.

“I think 9% is a fair return over the course of the deal. For an investor concerned about volatility, it’s a decent compromise. It’s a good way for nervous investors to immunize themselves from the volatility inherent to the product,” he said.

“This CD is going to accomplish the same thing as a low volatility fund. But you’re going to have the peace of mind because your principal is protected. That’s where the sweetener is in this deal.”

Solid return

The market-linked CDs offer only a 50% participation rate but an equity portfolio could average 9% to 10% a year, he said. The CDs offered a fair balance between equity returns and preservation of capital, he said.

“A 9% gain for the term is a solid return given that you don’t have the equity risk exposure and that you can get more. This is just the minimum gain,” he said.

When compared to a traditional CD, the 1.28% minimum return appeared “at first, kind of low,” he said.

“But you’re hoping to get not just the fixed return but 50% of the aggregate return. That could be something like 3% to 4% a year. It’s a nice CD for seven years. Giving up a higher fixed-rate for a greater return, that’s where you’re rolling the dice.”

Tradeoff

Kirk Chisholm, wealth manager and principal at the Innovative Advisory Group, compared the minimum annualized return of the CDs with the current seven-year Treasury yield of 1.78%.

“Worst case scenario, you get only 1.28% a year or 50 basis points below Treasuries. So you’re giving up 50 bps a year for the potential equity upside. You’re getting 9% versus 12.5% for the potential of earning equity-like returns,” he said.

“It’s a reasonable bet in this environment. The investment is a little bit too complicated to explain to traditional CD buyers but the risk-to-reward tradeoff is reasonable enough to consider.”

Goldman Sachs & Co. is the underwriter. Incapital LLC is distributor.

The CDs are expected to price Feb. 24 and settle Feb. 27.

The Cusip number is 38148D5L4.

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