The trading desks at Goldman Sachs ( GS) and Lehman Brothers ( LEH) are the champions of Wall Street, getting the most bang for their firms' bucks. A first-half analysis of earnings results for seven of Wall Street's biggest investment firms finds that the traders at Goldman Sachs and Lehman are most effective in generating big revenue for their employers. The worst, meanwhile, are the proprietary traders at Citigroup ( C), JPMorgan Chase ( JPM) and Merrill Lynch ( MER). The review, conducted by Brad Hintz, a Sanford Bernstein analyst, focused on risk-adjusted returns. To facilitate such a comparison, Hintz used a common securities industry metric that gauges a firm's exposure to trading losses on any given day, called "value at risk." He then divided a firm's total trading revenue by its average value at risk during the quarter. "We found that Lehman Brothers and Goldman Sachs were the best traders on Wall Street during
the first half of '06,'' says Hintz in the report. "And each firm, over the past two-plus years, has exhibited the strongest correlation between risk taken and trading revenues generated amongst it peers.'' The analysis by Hintz comes at a time that revenue from proprietary trading -- trading for an investment house's own account -- continues to propel earnings on Wall Street to record levels. Over the past few years, trading revenue has become the big cash cow for most investment firms, far surpassing the fees Wall Street firms generate from advising on corporate deals or underwriting stock and bond offerings. In terms of trading, Goldman Sachs is far ahead of the pack when it comes to generating revenue. The firm's trading operation generated $13.6 billion in revenue during the first six months of 2006, nearly three times as much as most other investment firms. Morgan Stanley, which ranked second in terms of trading revenue, took in $7.8 billion during the first half of the year.
But in Hintz's analysis, Lehman, which generated $4.98 billion from trading and principal investments during the same period, nudged out Goldman Sachs when it came to having the most efficient traders. Using his risk-weighted formula, Lehman's traders came up with a top score of 71.4. Goldman Sachs came in second with a score of 67. To some degree, the big surprise in Hintz's analysis was the strong third-place showing by traders at Morgan Stanley. A year ago, Morgan Stanley ranked near the bottom when it came to measuring trader efficiency. But the firm has turned things around in the past six quarters. Hintz attributes the improvement at Morgan Stanley to an effort by Chairman and CEO John Mack to revitalize the firm's trading operation and make it a more reliable earnings contributor. "Morgan Stanley was never a particularly aggressive trader,'' says Hintz, a former Morgan Stanley managing director. "It looks like Mack is giving these guys more resources and freedom.'' The improved performance at Morgan Stanley enabled the firm to beat out Bear Stearns ( BSC) in Hintz's rankings. Bringing up the rear in Hintz's analysis were Merrill Lynch, Citigroup and JPMorgan, all of which have had difficulty generating consistent revenue from proprietary trading. Hintz says the three firms show little ability to prosper from the risk their traders take on. "We question the true effectiveness of these firms' trading desks given the "arbitrary" relation between these firms' risk and reward,'' says Hintz.