Goldman's leveraged notes tied to S&P 500, MSCI EAFE offer uncapped gains, partial protection

By Emma Trincal

New York, May 12 - Goldman Sachs Group, Inc.'s 0% leveraged buffered basket-linked notes were seen as unusual by a financial adviser. The notes are leveraged both on the upside and the downside and yet offer a buffer on the downside and no cap on gains.

The basket includes the S&P 500 index with a 75% weight and the MSCI EAFE index with a 25% weight.

The notes will mature between 48 and 54 months after issue, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.05 to 1.2 times any basket gain. The exact upside participation rate will be set at pricing. Investors will receive par if the basket falls by up to 20% and will lose 1.25% for every 1% that it declines beyond 20%.

Risk/return parameters

"It's some kind of new structure that hasn't been done before," said Steve Doucette, financial adviser at Proctor Financial.

"It's a neat structure. On the upside, you get unlimited gains and leverage, and you do have some protection on the downside. These are neat risk/return parameters."

Doucette considered the 1.25 times leverage factor that applies to losses for each point of basket decline beyond 20%.

"The only times the 1.25 times factor becomes a concern is when your index declines by more than 36%, and I don't see this happening even in four years," he said.

"Up to a 20% decline you're protected. After that, you need an additional 16 points of decline to lose the 20%. That's when you get to the point where the downside leverage starts to kick in," he said.

Mean reversion

Doucette had some objections to the underlying basket. He said that the lower-weighted index - the MSCI EAFE - could outperform the S&P 500, which represents the bulk of the basket.

"The S&P 500 has been outperforming the EAFE since March '09, and we're already two years into the rally in the U.S.," Doucette said.

"I can see some sort of mean reversion here with the EAFE doing better than the U.S. I would have picked a different allocation for that reason."

The MSCI EAFE index is an equity market benchmark for developed markets outside of the United States and Canada. It represents the equity benchmarks of 22 developed markets in Europe, Australia and the Far East.

Matt Medeiros, president and chief executive officer at the Institute for Wealth Management, said on the contrary that he liked the underlying basket.

"It's a good allocation. The valuation on the S&P is attractive. Based on those two asset classes, I don't see a 20% downside in a four-year timeframe," he said.

Mild leverage

One aspect of the structure - the rather small amount of upside leverage - was not a concern for Medeiros.

"I'm not a huge fan of leverage to begin with. And with those two asset classes, I don't think more leverage would make a huge difference," he said.

"The EAFE and the S&P 500 are a core type of strategy. Most of your alpha derives from alternative asset classes such as commodities, for instance. There's not a huge incentive to extend your core strategy with leverage. You get more of a reward from alternative strategies," he said.

Goldman Sachs & Co. is the underwriter.

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