Goldman Sachs' autocallables linked to Russell 2000 offer good risk-adjusted return, value

By Emma Trincal

New York, Aug. 30 - Goldman Sachs Group, Inc.'s 24-month 0% autocallable buffered notes linked to the Russell 2000 index offer good pricing and potential return based on the risk level of the product, which is slightly lower than average, Suzi Hampson, structured products analyst at Future Value Consultants, said.

The notes will be called if the index closes at or above the initial index level on either of two call observation dates, which are expected to be 12 months and 18 months after the issue date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout will be 108% to 109% of par if the notes are called on the first observation date and 112% to 113.5% of par if they are called on the second observation date.

If the notes are not called and the index return is zero or positive, the payout at maturity will be par plus the maturity date premium amount, which is expected to be 16% to 18%. Investors will receive par if the index declines by 15% or less and will lose 1.1765% for every 1% that it declines beyond 15%.

The exact terms will be set at pricing.

"This is a straight autocallable with a call level of 100. It's quite standard. The only slightly different feature is that your call dates are more spread out in time," Hampson said.

"More often, we see autocallable notes with more frequent call opportunities, the most common type being the quarterly call. Here you only have two, in one year and 18 months from now. It's relatively few.

"The more call points there are, the more likely you are to get called. Fewer call opportunities offer higher coupons because the probabilities of a call are less.

"So this is what you have here: a lower probability of getting called but a higher coupon. It's the trade-off."

Hampson said that with this product as with any other autocallable, the highest probability of the call falls on the first observation date, which would be a year after pricing.

One year

"We have an 8% to 9% payout per annum. Call it 8% for argument sake. We would expect the call to fall on the first year date. That's when you get your capital back and your 8%. A call obviously forces the investor to reinvest the money without any guarantee to find a similar yield. But at least the principal is safe and they made their 8%," she said.

"Some investors might find it appealing to have the first call date after one year rather than three months. That way they may get the full 8% instead of 2%. Even if the annualized rate is the same, this may have some appeal for some investors reluctant to face reinvestment risk too soon or too often.

"Usually investors invest in these products in the hope that the notes will be called. It's the safest scenario.

"If you get to maturity without having been called, there is a greater chance you may lose some principal.

"They give you a 15% buffer, which is quite decent. But if you get to maturity, it means you have missed two calls. It indicates that after one year and after 18 months, the index was below its initial price. You could be unlucky and finish at 99. Or the index can always go back up in the last six months. But missing the two call dates in a row is not a good sign. If it happens, there is a good chance to finish below the buffer."

The notes have a lower risk profile than other autocallables but also display less risk than the average of all products recently rated by the research firm.

"Autocalls tend to have less risk than other products because once the notes are called, the risk exposure is removed and investors receive the integrality of their investment," she said on the riskmap of the product.

The riskmap is a Future Value Consultants rating that measures on a scale of zero to 10 the risk associated with a product with 10 being the highest level of risk possible.

Less risk

The notes 'riskmap is 2.97, compared with an average riskmap of 4.18 for the same group of products and 3.97 for the "all-product" category, which is how Future Value Consultants designates all the products it recently rated.

The riskmap is the sum of two risk components: market risk and credit risk.

"It's mostly the market risk that decreases risk with this product," she said.

At 2.29, the market riskmap is "considerably less" than the average of the same product type at 3.85 and also less than the all-products category, which has a 3.50 average market riskmap, she noted.

On the other hand, the credit risk is slightly more at 0.68 versus 0.33 for the same product type and 0.48 for all products, she added.

"Overall we have a level of risk that's quite below this product type and below the average of all products as well," she said.

"The comparison with the same product type shows that the lower risk comes from a combination of factors. First you find in the autocallable group products that have no protection or lower levels of protection than this one; you also get products tied to several underlying such as worst of, which are much more risky. Finally the Russell 2000 is a little bit more volatile than the S&P 500, but we have products that are tied to much more volatile indexes or even to stocks."

The Russell 2000 has a one-year implied volatility of 20.5%, compared with 17.5% for the S&P 500.

"Compared to all products, the autocall feature mitigates risk. Among all products you find a wider range of underlying which are more volatile. You also have an overwhelming number of reverse convertibles, which are more volatile in nature. All these factors help explain the lower riskmap as well as the lower market risk," she said.

Hampson attributed the higher credit risk associated with the product to the duration of the product rather than the issuer's creditworthiness.

"When you compare it to all products, it could be the length factor. You're looking at three-month reverse convertibles among the all-product-type category. As we know, the longer the term, the higher the credit risk," she said.

The explanation for the product's higher credit risk when compared to its peers also derives from the duration of the notes, she explained.

"We look at the expected duration versus the maturity. So we find a duration between one and two years, which is longer than similar products that have more frequent call dates. An autocall with a quarterly observation date for instance is expected to kick out earlier than this one," she said.

"We run all the call points and applicable probabilities into our Monte Carlo model to estimate the expected maturity. Since a great number of autocallables have more frequent call dates, this product is obviously going to show a longer expected duration than average.

"This is probably why the credit riskmap is twice higher."

Return above average

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

The notes score 6.93 on the return scale, which is better than the all-product score of 6.72 and even higher than the average of the same product type, which is 6.39, she said.

"This metric is really a measure of the risk-adjusted return. We have a score that's way above average. It gives you an idea of where the return falls given this particular level of risk. Having an above-average risk score doesn't mean the product is offering the best return. It's just a way of comparing two products with different risk profiles," she said.

"Comparing two different structured products is always a challenge because of all the different terms, factors and aspects of pricing. The score gives you a way to compare products more effectively."

According to the probability table associated with the low-volatility scenario applicable to this product, investors have a nearly 78% chance of generating a positive return versus a 22% probability of losing some or their entire principal.

Price, overall

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.

The price score for the product is 7.98, versus 7.08 for its peers.

"It's considerably higher. It's a value for your money type of indicator," she said.

"We calculate the estimated fees per annum, which are based on the expected duration. It's scoring much better. Maybe because it hasn't priced yet. One of the terms, the call premium amount, is stated in a range. We have between 8% and 9%. It's not such a big margin, but it adds an element of uncertainty. Also a factor that may help the score is the expected duration, which is assumed to be longer than other products."

Overall score

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

The 7.45 overall score of the notes beats the 6.73 average overall score seen for the same product type. The overall score for all products at 6.76 is also lower.

"We've had good scores all across the board - a good return score, price score - so it's not a surprise to find a higher than average overall score. It's quite a simple and well-priced deal for investors looking for a target return who are not overly bullish. Those products perform well in a low-volatility environment and may be suitable for people who are prepared to deal with an early redemption and the uncertainty around the term," she said.

"This is a structure that has been around a long time. Anybody using structured products is aware of it. When you have fewer call points, there is a potential for higher returns.

"While there is always uncertainty around the real duration of an autocall, there is also less risk in these products than with a growth product simply because the call brings the risk back to zero."

Goldman Sachs & Co. is the underwriter.

The notes are expected to price in September.

The Cusip number is 38147QFA9.

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