Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Morgan Stanley Plans Expansion in Fixed-Income

During 2009, Morgan Stanley dramatically underperformed both Goldman Sachs and JPMorgan in the performance of its securities business, particularly in the area known as FICC (fixed-income, currencies and commodities). The Financial Times article from February 1st 2010 entitled Morgan Stanley In Hiring Push has more details.

According to Morgan Stanley's new chief executive, James Gorman, Morgan Stanley plans to hire several hundred new traders over the next several years to hopefully close the gap with Wall Street trading rivals. Rather interestingly, he stated "We are not showing clients enough. We don't have people on the ground. We are not sufficiently penetrated with large clients and there are some smaller clients we are missing out on." He continued: "We need to seriously grow our footprint in products like currencies, equity derivatives and commodities. We could easily be 25 percent bigger than we are. [Investor's] bias is to do more business with [Morgan Stanley], the burden is on us to deliver."

What Toomre Capital Markets LLC ("TCM") finds so interesting with the article is the degree to which Morgan Stanley under-performed. Apparently, in 2009 Morgan Stanley had revenues of $5bn in fixed income trading (or $8.8bn excluding an accounting loss) compared with $17.6bn at JPMorgan and $23.3 recorded by Goldman Sachs. Put another way, Morgan Stanley's FICC unit only generated revenues one half of JPMorgan's revenues and thirty-eight percent of what Goldman Sachs recorded. WOW!! Clearly Morgan Stanley is not even close to its two rivals in this business area, which is counter to what many market participants perceive.

The article concludes with the thought that the need to add more traders and sales people to better staff the basic product areas of this business unit is an admission that at least one of former CEO John Mack's decisions was wrong. His decision to focus on various complex derivatives and associated products popular before the credit crisis left Morgan Stanley ill equipped to benefit from the pick-up in the trading of simpler fixed-income products.

TCM further wonders whether Morgan Stanley's staffing up to support customer business flow in the simpler product areas is coming at an inopportune time. Over the next three years, the United States and world economies are likely to begin to grow again leading at some point to a pick-up in inflation and increases in interest rates. Such a scenario is generally a bear market for fixed-income instruments and traditional investors in such securities have historically reduced their activity rates because of an unwillingness to realize capital losses by selling fixed-income at a rate of return higher than that which they originally were purchased. During such periods, the bid/ask spreads on traditional fixed-income instruments have tended to narrow because of increased competition to get one of the relatively fewer trades.

Similarly, during periods of relative stable interest rates, competition with other Wall Street firms has caused spreads in well-developed products to narrow as well. This phenomenon partially explains why the Wall Street types have always been on the look-out for new ideas and/or products that have "wider" profit margins. Since the early 1980's, many of those ideas have come from the need to better finance consumer credit and mortgages. The wide-spread adoption of derivatives to "offset" or minimize various portfolio risks also was a very profitable concept, at least initially.

One has to wonder whether Morgan Stanley is managing their FICC business for the current fiscal year or for what might be coming over the next several. TCM will be very curious to see how well Morgan Stanley performs in this business over the next three years compared to its rivals. Comments and other thoughts are welcome.