Morgan Stanley stumbles in rough trading

October 20, 2010

Morgan Stanley has paid a steep price for trying to trade its way through tough markets and has failed to reap much of a reward.

In contrast to rivals Goldman Sachs and JP Morgan , which have both been reducing the amount of risk they hold in their trading book, including for commodities, Morgan Stanley has kept trading risk at a high level in a bid to catch up after falling behind in 2008-2009.

Its daily value-at-risk (VaR) allocated to commodity trading averaged $32 million in the third quarter, up from $29 million in the second and $27 million in the first. Commodity VaR was the highest for the bank since the three months ended August 2008.

Morgan Stanley has been pursuing the opposite strategy to its archrival in commodities in recent years. In 2009 and early 2010, while Morgan Stanley cut commodity VaR sharply, Goldman was boosting its own risk allocations. Now that Goldman has begun to trim commodity VaR, Morgan Stanley has raised its own risk profile.

The decision to expand commodity VaR reflects a broader increase in risk appetite across the bank’s trading book. Firm-wide VaR net of diversification effects rose to $142 million in Q3 from $139 million in Q2, and $143 million in Q1. Firm-wide VaR is up 20 percent compared with the same quarter a year ago. In contrast Goldman has cut VaR by 40 percent.

But more risk-taking has not yet translated into higher profits. Morgan Stanley’s net revenue from trading slumped to just $1.4 billion in Q3, down from $3.4 billion in Q2 and $3.4 billion in Q3 2009.

Trading efficiency has fallen. Morgan Stanley generated $15.90 of net revenues for every $1 of average VaR in Q3 2010, down almost half from $29.60 in Q3 2009. In contrast, Goldman Sachs has kept trading efficiency at around $32-33 of net revenues per $1 of VaR.

Morgan Stanley is generally reckoned to have fared worse in the credit crisis than its main rival. Business leaders have been under pressure to stabilize the growing gap with Goldman Sachs and protect the firm’s commodity franchise in the face of ambitious expansion plans at Barclays Capital , Deutsche Bank and JP Morgan.

But with trading conditions getting tougher, the decision to keep risk appetite unchanged to make up ground does not seem to have paid off in Q3. Faced with directionless markets, few big tradable trends and a rise in volatility, most of the other commodity banks cut VaR in a bid to protect efficiency. Morgan Stanley kept risk on its books but failed to get much benefit.

In a sign of how tough commodity trading has proved in the past few months, none of the big three commodity banks to announce results recently (JP Morgan, Goldman Sachs and Morgan Stanley) chose to highlight commodities in their earnings releases.

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