GS Finance’s $16.6 million notes tied to European banks reweight index for less concentration

By Emma Trincal

New York, Sept. 6 – GS Finance Corp.’s $16.6 million of 0% autocallable buffered notes due Sept. 4, 2020 linked to a basket of the 25 stocks included in the Euro Stoxx Banks index offer the latest illustration of a simple smart beta strategy consisting of reweighting an index in order to add diversification to the underlying basket.

The calculation agent selected the 25 basket stocks from the Euro Stoxx Banks index on Aug. 7 and reweighted the basket using a specific methodology described in the prospectus. The objective is to apply a 5% cap for the weight of each stock.

For instance, Banco Santander SA, which as of Aug. 7 had a 16.23% weight in the index, has been given a 5% weight in the basket.

Investors get paid when the notes are called or possibly at maturity. The notes will be automatically called at par plus a call premium if the basket closes at or above the initial basket level on Sept. 28, 2018 or Aug. 30, 2019.

The call premium is 13% for the first call observation date and 24% for the second call observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the basket return is zero or positive, the payout at maturity will be par plus 36%. Investors will receive par if the basket declines by 10% or less and will lose 1.1111% for every 1% that it declines beyond 10%.

Smart and easy beta

Equity basket-linked notes can be among the largest in size in the U.S. structured notes market, according to data compiled by Prospect News.

A typical example this year as in past years (the offering comes out twice a year) is Bank of Montreal’s one-year notes linked to Raymond James Analysts' Best Picks for 2017, which priced at $310.24 million in January.

Reweighting stocks in an existing index is a more passive process than creating a basket of best picks, a fund analyst said.

“They’re just changing the weights to make sure there is not a huge amount of concentration in a couple of names,” he said.

“You still have exposure to a particular sector but with the risk being spread more evenly.”

Structuring notes around those re-weighted indexes remains a relatively little-noticed trend, he said. But for some investors, such baskets are the preferred route rather than the direct or indirect use of the index itself.

“I couldn’t say for sure if it’s a retail product or an institutional product. I think some advisers don’t like highly weighted indices. They need the diversification. It also depends a lot about the type of index you’re talking about,” he said.

European banks

A market participant said the concept behind the basket made sense as a diversification tool. But more diversification is not necessarily the equivalent of protection, he added.

“This is not exactly equally weighting, but it’s close. You just cap the weighting at 5% so that you can stop the 800-pound gorilla in this index, whichever it is, from having that much weight,” he said.

He commented on the structure with a specific view on the underlying asset class.

“Personally and that’s just me... I don’t see a whole lot of protection on the downside based on this sector. A 10% buffer is fine but it may not be enough for European banks, which tend to be more volatile than domestic banks,” he said.

Goldman touch

An industry source said the size of the offering was significant for this kind of deal.

“That’s a good trade. It’s probably based on some of Goldman’s research on this particular market,” he said.

But the concept of rearranging the weightings of an existing index was not new for this agent, he added.

“Goldman is kind of at the forefront of taking an index or an ETF and playing with it.

“They’ve been doing this for three years by equal-weighting them, putting caps on them and so on.

“It’s not the first time Goldman does a reconfiguring on an index or ETF especially when it comes to Europe.

“They did that with Italian stocks a few years ago.”

Goldman Sachs Group, Inc. indeed priced $30.56 million of notes linked to a basket of the shares of the 24 Italian companies included in the MSCI Italy index in June 2014. The 5% cap was applied on each stock.

Turning to Spain more recently, GS Finance Corp. priced $3.31 million of 13-month leveraged notes linked to a basket of shares of the 24 Spanish companies included in the MSCI Spain 25/50 index using the same 5% cap for each weight. The deal priced in July.

A year before, Goldman distributed Toronto-Dominion Bank’s $22.97 million of leveraged capped buffered notes due May 3, 2018 linked to this Spanish basket.

JPMorgan also priced similar deals on Spanish stocks applying a cap to the index constituents of the MSCI Spain 25/50 index.

Basket constituents

The basket includes Banco Bilbao Vizcaya Argentaria, SA, Banco de Sabadell SA, Banco Santander SA, BNP Paribas SA, CaixaBank SA, Credit Agricole SA, Commerzbank AG, Deutsche Bank AG, Erste Group Bank AG, ING Groep NV, Intesa Sanpaolo SpA, KBC Group NV, Societe Generale SA and UniCredit SpA, each with a 5% weight; ABN Amro Group NV with a 4.74% weight; Bank of Ireland with a 3.63% weight; Natixis SA with a 3.3% weight; Mediobanca SpA with a 3.02% weight; Bankinter, SA with a 3% weight; Banco BPM SpA with a 2.8% weight; Bankia SA with a 2.33% weight; Unione di Banche Italiane ScpA with a 2.3% weight; BPER Banca SpA with a 1.31% weight; Raiffeisen Bank International AG with a 1.93% weight; and FinecoBank Banca Fineco SpA with a 1.64% weight.

Goldman Sachs & Co. is the underwriter for last week’s $16.6 million deal, which priced on Thursday.

The notes are guaranteed by Goldman Sachs Group, Inc.

The Cusip is 40054LQ64.

The fee is 2.125%.

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