Goldman Sachs Structured Equity Funds
Fundamentally Based, Quantitatively Constructed, Efficiently Traded
NOT FDIC-INSURED
May Lose Value No Bank Guarantee
Goldman Sachs Structured Equity Funds • Intelligent management • Fundamental investment themes • Portfolio optimization
Index (passively managed) Funds • Passive, automatic operation
Traditional (actively managed) Funds • Low tracking error • Lower expenses
• Track their benchmark
• Potential to outperform benchmark • Can change weightings as markets change
• High tracking error • Investment bias — can “fall in love with a stock”
The Structured Advantage When selecting “foundation” investments — often broadly diversified U.S. and international stock and bond funds — many investors rely on either Index funds (passively managed) or Traditional funds (actively managed). At GSAM, we believe that including Structured funds in this mix is a more efficient approach that offers higher risk-adjusted return potential. J Like Index funds, Structured funds offer broad diversification and resemble their benchmarks — leading to relatively low tracking error and fees. J Like Traditional funds, Structured funds capitalize on skilled portfolio managers who guide the investment process — and aim to outperform their benchmarks.
Core and Satellite: One way to use Structured funds Core and Satellite portfolio construction is an increasingly popular way to build investment portfolios. Core investments are stocks and bonds that are exposed primarily to market risk. These form the financial foundation of a long-term investment portfolio. Satellite investments offer layers of diversification and “alpha,” or additional return potential generated by skilled active management. These might include emerging markets equity, real estate, high yield bonds or private equity investments. We believe that, together, Core and Satellite investments create a sounder, more efficient portfolio than either could alone.
I. Fundamentally Based At Goldman Sachs Asset Management (GSAM), Structured Equity combines traditional fundamental analysis with sophisticated quantitative modeling. Our approach is not unlike that of a more Traditional active manager: we look at fundamental investment themes that have been effective historically in forecasting excess returns of stocks.* However, where we differ from Traditional managers is that we rigorously test every potential research theme or signal to make sure they have shown consistent predictive ability across a wide variety of stocks in different time periods and under different market conditions. We then use these variables to evaluate our universe of stocks in a disciplined manner; this discipline helps prevent our own biases from undermining our stock analysis.
Six fundamental themes drive our stock selection: PROFITABILITY What are the company’s profit margins? How efficient are its operations? Metrics: Earnings-to-sales ratio Sales-to-total-assets ratio VALUATION How is the company priced relative to fundamental accounting measures? Metrics: Price-to-book ratio
EARNINGS QUALITY Were earnings derived from sustainable sources? Metrics: Accruals-to-total-assets Write-offs to bad-debt-expense
XYZ Co. Expected Excess Return
MANAGEMENT IMPACT How is the company’s management employing its capital? Metrics: Change in shares outstanding
ANALYST SENTIMENT Are analysts upgrading or downgrading their view of this company? Metrics: Earnings forecast revisions Recommendation changes
MOMENTUM How has the market responded to the company’s changing fortunes? Metrics: Earnings response Price momentum Short-term reversals
When it comes to stock selection, we do what good Traditional managers do — evaluate stocks based on fundamental themes that have outperformed historically. However, we believe our process is better because we: J Calculate expected returns for approximately 8,500 stocks on a daily basis. J Create a quantitative ranking for each. J Eliminate the bias and emotion — falling in love with a stock — that often characterize Traditional managers’ stock selection.
*Past performance is no guarantee of future results.
II. Quantitatively Constructed We construct portfolios using an optimization process that examines many possible combinations of stocks with the goal of finding one combination which maximizes expected return potential (net of transaction costs) for a given level of risk. In other words, we seek to create a portfolio that looks and feels a lot like the benchmark in all areas in which we don’t feel we have an informational advantage — such as size and style deviations or sector over- and underweights — but is positioned to outperform through better stock selection. By eliminating unproductive and unintended “bets,” our performance is more likely to reflect (sustainable) skill than (unsustainable) luck.
One of the industry’s largest Quantitative Equity teams Although the portfolio construction process is driven by computer optimization, it could be performed manually by GSAM’s broad, deep Quantitative Equity team. It is simply faster and more efficient to use technology. GSAM’s Quantitative Equity team includes: J More than 70 quantitative investment professionals, including researchers, portfolio managers and strategists, and information technology experts* J 13 PhDs and 15 CFA charter holders* J The same Chief Investment Officer who created this process in 1989
III. Efficiently Traded The third step in GSAM’s Structured Equity investment process — and one that also drives performance — is efficient trading. For example, the team uses internally integrated trading systems and weighs transaction costs in every decision. This focus on efficient trading reflects the fact that lower trading costs are a risk-free source of added performance for investors.
When it comes to portfolio construction, we do what good Quantitative managers do — allocate risk to our best investment ideas, construct portfolios that neutralize systematic risks, and trade efficiently. However, we believe our process is better because we: J Use a unique, proprietary risk model that we believe is more precise, more focused and faster to respond. J Manage risk from sector bets, market timing, style bias and other factors while maximizing return potential from our fundamental themes. *As of March 31, 2006.
Three “As” of Structured Funds J Accuracy Proprietary computer models and active application from a team of experts J Agility A risk model that uses daily returns to adjust rapidly as levels and sources of risk change J Attribution Knowledge of how each investment theme has contributed to returns
Structured Managers: Comparable Returns at Lower Levels of Risk One way to judge a manager is through Information Ratio, which measures skill and efficiency in using risk. For example, a manager that achieves a 1% alpha (excess return over a benchmark) at a 3% tracking error is twice as skilled as a manager that achieves a 1% alpha, but at a 6% tracking error. As the chart below shows, Structured managers have higher information ratios than Traditional managers at all skill levels. That’s the result of greater risk management and lower targeted tracking error. Information Ratio (%) (1990 – 2005)
Information ratio
0.58 0.36
Structured managers Traditional managers
0.30 0.12
-0.01 -0.11 Top quartile
Median
Bottom quartile
The information above relates to the management of certain institutional separate accounts, not mutual funds. It is being shown for illustrative purposes only, to demonstrate the potential results of Traditional management versus Structured management. Source: PSN. The data provided above is estimated. Accordingly, estimated returns are subject to change and actual returns may vary from the performance information presented above. Estimated returns should not be construed as providing any assurance or guarantee as to actual returns. The above analysis was done based on all US large cap managers in the PSN universe as of December 2005 with at least 5 years of history. Managers included had at least five consistent years of data over the past 15 years though not all managers were included in the latest period 20012005. There were 235 Structured managers and 743 Traditional managers. Structured managers are defined as those with realized tracking errors between 0.5 and 4%. Traditional managers are defined as those with realized tracking errors between 4% and 12%. Past performance is not indicative of future performance, and the institutional separate account past performance set forth herein does not represent past or future performance of any mutual funds. Mutual fund performance may differ from that of separate accounts due to a number of factors, including without limitation, potentially differing rates of fees and expenses applicable to a fund, cash levels and investment timing issues, as well as regulatory considerations that would impact performance relative to a separate account. For any information about any Goldman Sachs Fund, please visit www.goldmansachsfunds.com.
GOLDMAN SACHS STRUCTURED EQUITY FUNDS Goldman Sachs Structured Tax-Managed Equity Fund
Russell 3000 Index
Goldman Sachs Structured U.S. Equity Fund
S&P 500 Index
Goldman Sachs Structured Large Cap Value Fund
Russell 1000 Value Index
Goldman Sachs Structured Large Cap Growth Fund
Russell 1000 Growth Index
Goldman Sachs Structured Small Cap Equity Fund
Russell 2000 Index
Goldman Sachs Structured International Equity Fund
MSCI EAFE Index
There can be no assurance that a mutual fund will achieve its investment objective. The Funds are subject to market risk which is the possibility that the market values of securities owned by the Fund will decline and the value of fund shares, when redeemed, may be less than what you paid for them. In addition, the Funds are subject to various other special risks. The Structured International Equity Fund’s investments in foreign and emerging market securities may be more volatile than investments in U.S. securities and will be subject to the risks of currency fluctuations and sudden economic or political developments. The Structured Small Cap Equity Fund invests in small- and mid-size company stock. Investments in small- and mid-size company stock typically involve greater risk, particularly in the short term, than investing in larger, more established companies. The U.S. Equity Dividend and Premium Fund is subject to the risks associated with writing (selling) call options. The Structured Tax-Managed Equity Fund’s tax-managed strategies will reduce the amount of taxable income and capital gains distributed by the Fund to shareholders. This Fund is not suitable for IRAs or other tax-exempt or tax-deferred accounts.
For more information, please contact your Investment Professional. Indices are unmanaged and Index figures do not reflect any deduction for fees, expenses or taxes. It is not possible to invest directly in an unmanaged index. The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization. The S&P 500 Index is the Standard & Poor’s 500 Composite Index of 500 stocks, an unmanaged index of common stock prices. The Russell 1000 Value Index is an unmanaged market capitalization weighted index of the 1000 largest U.S. companies with lower-price-to-book ratios and lower forecasted growth values. The Russell 1000 Growth Index is an unmanaged market capitalization weighted index of the 1000 largest U.S. companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Index is an unmanaged index of common stock prices that measures the performance of the 2000 smallest companies in the Russell 3000 Index. The unmanaged MSCI EAFE Index (unhedged) is a market capitalization-weighted composite of securities in 21 developed markets. Effective December 30, 2005, the CORE International Equity, CORE Small Cap Equity, CORE Large Cap Growth, CORE Large Cap Value and CORE U.S. Equity Funds were renamed, respectively, the Structured International Equity, Structured Small Cap Equity, Structured Large Cap Growth, Structured Large Cap Value and Structured U.S. Equity Funds. Effective January 6, 2006, the CORE Tax-Managed Equity Fund was renamed the Structured Tax-Managed Equity Fund. CORESM is a registered service mark of Goldman, Sachs & Co. Prospectuses for the Funds containing more complete information may be obtained from your authorized dealer or from Goldman, Sachs & Co. by calling 1-800-526-7384. Please consider a fund’s objectives, risks, and charges and expenses, and read the prospectus carefully before investing. The prospectuses contain this and other information about the Funds. Goldman, Sachs & Co. is the distributor of the Goldman Sachs Funds. Goldman Sachs Asset Management J 32 Old Slip, 32nd Floor J New York, New York 10005 Copyright 2006 Goldman, Sachs & Co. All Rights Reserved. Date of first use: June 1, 2006. 2006-0780 / 5K / STRUCTBRO / 06-06