Goldman's notes tied to S&P 500 are built for defense, but upside, protection type disappoint

By Emma Trincal

New York, Aug. 22 - Goldman Sachs Group, Inc.'s 0% trigger notes due Sept. 10, 2014 linked to the S&P 500 index offer a relatively short term, a barrier on the downside and upside participation with a cap but no leverage, according to a 424B2 filing with the Securities and Exchange Commission.

"You buy the market exposure with a barrier. The question is whether you get the right protection," said Steve Doucette, financial adviser at Proctor Financial.

One-for-one

One additional feature of the deal is a minimum contingent return of 0.5%, which sources said is unusually low and may not offset the absence of any other return enhancement features.

If the index's closing level is at least 80% of the initial index level on every trading day during the life of the notes, the payout at maturity will be par plus the greater of 0.5% or the index return.

Otherwise, the payout will be par plus the index return, which could be positive or negative.

In each case, the payout will be subject to the 15% cap.

"It's for someone who has a range-bound view on the market. They expect the market to trade between minus 20% and plus 15%. What they want is the market exposure to the upside with some protection," Doucette said.

One issue of concern with the product is the existence of a cap with no real leverage, sources said.

Most one-year participation S&P 500-based notes without leverage have barrier levels of 75% to 80% - in line with the notes, according to data compiled by Prospect News. But many of them do not have a cap, according to the data.

On the other hand, leveraged notes of the same maturity tied to the same underlying typically would have smaller buffer amounts - 5% for a two-times factor, for instance, and 10% for a 1.2- to 1.5-times factor, according to the data. But some of those protections are offered in the form of a buffer or a final barrier, the equivalent of a European option rather than an American type of barrier, which can be triggered any day as it is the case with the notes.

"The only upside enhancement that you get here is the minimum contingent return of 50 basis points. So if the index is down 19%, you'll get 100.5% instead of par. That's not much," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

Buffer preferred

Doucette said that he would demand a different type of protection than the one built into the structure.

"The person buying those notes is saying, I don't think this market is ever going to go up more than 15%, so leverage or not, you're still capped at 15%. And 15% is not a bad return, by the way," he said.

"They want to stay in the market, but they want some downside protection.

"That's fine except that I would probably not want to use a barrier, even if it's an 80% barrier.

"We've been 50 months into a bull market, and the average bull market runs 53 months. If there was a pullback, I don't think I'd want a barrier. You can easily breach that 20% threshold. Who knows what the market will be like a year from now?

"I would rework the terms to be sure that we would outperform the downside if there was a big drop."

The one-year tenor, while appealing, is not necessarily going to lead to the best terms.

"When you start looking at duration, that's the problem. With a one-year duration there is only so much flexibility," he said.

"By virtue of where we are in the market cycle, protections are costing you more. If you still want protection, especially on a one-year, you're going to give up the upside.

"We would still work on getting a buffer. We always look to outperform the market on either direction because no one really knows which way the market is going."

No equity reward

Medeiros said that he does not really see the value of the security.

"I'm unclear on how this note fits into a portfolio or what would be the objective," he said.

"I guess it would be for somebody who wants exposure to the broad market and who still thinks the S&P has a little bit of tailwind into it but is not overly convinced.

"My perspective is that the S&P 500 obviously has had a nice run so far this year even though it pulled back a little bit just recently. But I'm not a fan of taking equity risk and not getting paid with equity reward.

"I like the protection, but I would prefer a note without a cap, especially if there is no leverage on the upside.

"I don't know if the S&P 500 will appreciate more than 15%. However, if it does and you're taking the risk of the index, you should be rewarded."

Having no leverage is also a concern, he noted.

"If I had to invest in a tracker note, I would want both the buffer and no cap. With this, you get a barrier that can be breached any day and a cap on the upside," he said.

"What you get in exchange isn't much. If you're down by less than 20%, they'll give you 100.5% instead of par. It's sort of inconsequential. It's a 'thank you for being with us for a year.' You might as well say par."

The notes (Cusip: 38147QPS9) are expected to price on Friday and settle on Wednesday.

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

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