GS’s relative performance notes tied to S&P 500 versus basket seen as not straightforward

By Emma Trincal

New York, Jan. 11 – GS Finance Corp.’s 0% relative performance notes due Jan. 25, 2017 linked to the performance of the S&P 500 index and a basket that includes the Health Care Select Sector index, the Technology Select Sector index, the Consumer Discretionary Select Sector index and the SPDR S&P Bank exchange-traded fund were too complex to explain to a client and the outcome was not “straightforward,” financial advisers said.

Multiple paths

If the basket performance is positive and the S&P 500 return is positive or zero, the payout at maturity will be par plus the basket performance, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket performance is positive but the S&P 500 return is negative, the payout will par plus the basket performance plus the S&P 500 return. In this case, the return on the notes could be positive or negative and will be negative in the event that the decline in the S&P 500 is greater than the basket performance.

If the basket performance is zero or negative and the S&P 500 return is negative, investors will be fully exposed to the decline of the S&P 500.

If the basket performance is zero or negative but the S&P 500 return is positive, the payout will be par.

If the basket performance is zero or negative and the S&P 500 return is zero, the payout will be par.

Simplicity

Carl Kunhardt, wealth Advisor at Quest Capital Management, said he was not even willing to explore the payout ramifications based on the various relative performance scenarios because the “complexity” of the terms was just too great.

“This reminds me of a conversation I had 20 years ago with a gentleman who was a mentor to me. He used to tell me: ‘Carl, sometimes we try to be too smart for our own good. We think that just because we have the knowledge and that others don’t, we’re superior to them,’” he said.

“Goldman Sachs seems to be an inordinate depositary of that hubris.”

Kunhardt said that it was “important” to understand the difference between investing and gambling.

“Investing is assuming a risk in order to obtain a return with a reasonable expectation of a return based on your research,” he noted.

Strategy

“There is no research here. You’re playing odds. That to me is pure gambling.

“If you really believe in some sectors versus the benchmark, do a Dorsey Wright portfolio based on a sector rotation strategy,” he added.

Dorsey, Wright & Associates is a registered investment advisory firm that provides research and money management for financial advisers based on technical analysis.

“With this note, you’re not following a sector rotation strategy, you’re not having any kind of view about what sector will be outperforming in a year.

“It’s outright gambling.

“This is just Goldman Sachs being Goldman Sachs.”

Relative value bet

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, objected to the terms as well.

“First, this is way too complicated for a client,” he said.

But he also questioned the rationale behind the investment, analyzing the outcomes as described in the prospectus.

“This is written as a bet on four selected sectors against the benchmark. Your assumption is that the basket will outperform the S&P 500. That’s fair in this market environment. These sectors have done well and should continue to do well.”

Four possibilities

He considered the four potential scenarios.

In the first one, both the S&P 500 index and the basket have a positive performance.

“This is fine. You won your bet. You get the basket return,” he said.

Second scenario: The basket is positive and the S&P 500 index is negative. Investors receive the sum of those two returns. If the S&P 500 index declines more in absolute terms than the amount of basket gain, investors will incur a loss, according to the prospectus. On the contrary, if the benchmark decline is inferior to the basket gain in absolute terms, investors will have a profit.

“The S&P is not going to deviate too much from any of these sectors,” said Chisholm.

“I’m not sure it’s a great scenario. If I’m bullish on this basket, why would I want the S&P to drag me down? If I think the basket is going to outperform the index, why invest in the notes?”

With the third scenario, both the S&P 500 index and the basket are negative, which links investors’ return to the performance of the S&P 500 index only.

“Why getting the S&P return when the whole point was to bet on the outperforming basket? This is a scenario where you lose no matter what. But the amount of losses will vary depending on which one of the underliers declined the most. If you believe in the basket, you should have your return tied to it, not to the S&P,” he said.

In the fourth scenario, the basket is negative but the S&P 500 is positive or flat.

“No loss, no gain. I get my principal back. If there is any benefit of owning this over the basket, that’s in this last possibility,” he said.

Notes versus basket

“I think this note is not a good deal. If you’re investing in this product because you think the basket will outperform, you’re not benefiting from it,” he said.

He compared the four possible outcomes for a noteholder with a hypothetical investment in the sole basket.

With the first scenario, both the index and the basket are positive and investors receive the basket return.

“There is no benefit over investing in the basket,” he said.

With the second assumption, the basket is positive and the S&P is negative. Investors receive the difference.

“No benefit to owning the note over the basket either.”

The picture was mixed in the third scenario.

“When both are negative and you get the S&P return, you will lose anyway. I would say you can benefit in this case in terms of reducing your losses, but that’s only if the basket declines more than the S&P. It goes against your initial assumption. If you think the basket will outperform and you’re right, you’re worst of with the notes.

“Finally in the last scenario you are protected but you’re not getting any of the upside in the S&P.

“The only time the notes benefit you is if both things are down and if the S&P drops less than the basket.”

Chisholm considered the sector picks and the timeframe.

“They chose sectors that are in positive trend. I like those four sectors although one year is too short. For the next year, I wouldn’t want to own any of this stuff.

“This note is definitely not straightforward.

“There is no immediate benefit, no particular thesis.

“You’re looking at five indexes. It’s not one-sided scenario.

“Trying to predict for the next 12 months what’s going to happen doesn’t seem reasonable to me.

“I can’t put a probability on any of them.

“It’s not obvious. It’s highly unpredictable.

“As an investor, it doesn’t make sense to me and therefore I couldn’t look at something like that.”

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

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

The basket performance will equal the average of the basket components’ returns.

The pricing date was Friday.

The Cusip number is 40054CAX2.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.