To Weather Rocky Period, Goldman Makes Riskier Bets
Investors Worry as Traders Make Brash Bets Using Firm's Own Cash
By GREGORY ZUCKERMAN and SUSANNE CRAIG
Staff Reporters of THE WALL STREET JOURNAL
Early this year, as Goldman Sachs Group Inc. saw its investment-banking business faltering in a weak stock market, Peter Gerhard flew to London with a plan to boost profits. One of the firm's top trading executives, he met with a small, low-profile team there that makes big bets with Goldman's own money on everything from the Swiss franc to U.S. bond futures.
You have to step up your game and increase your risk, Mr. Gerhard told the group's leader, Christian Siva-Jothy, and other managing directors in a Goldman conference room on Fleet Street, according to a person at the meeting. Through a spokesman, Messrs. Gerhard and Siva-Jothy decline to comment.
This select group of Goldman's "proprietary" traders has been doing just that. The team, about a dozen people in all, including some in New York and two senior managers who trade on the side, has racked up impressive gains of more than $600 million so far this year, according to people familiar with the matter. That could yield as much as 15% of Goldman's pretax earnings, Wall Street analysts estimate.
If you add in the cash generated by about 30 other Goldman traders speculating with the firm's money, proprietary trading in a wide range of investments now could account for 25% or more of Goldman's income before taxes, analysts estimate. That is a bigger proportion than the historical percentage at Goldman and a larger share than the 5% to 20% that is typical of proprietary trading at rival firms, Wall Street analysts and executives say.
Despite its legendary reputation as a staid adviser on mergers and other corporate deals, Goldman has increasingly grown more dependent for its profits on aggressive traders betting with the firm's cash.
The Goldman strategy is similar to that of a baseball coach who exhorts his heavy hitters to swing for the fences when his team is down. Its proprietary trading has improved the firm's overall financial results in one of the worst periods for the securities industry in recent years. For the nine months that ended Aug. 30, Goldman's net income fell 11%, to $1.61 billion, compared with the same period a year earlier. However, net income increased 12% for the fiscal third quarter of this year, compared with last year's third quarter.
Goldman declines to discuss what percentage of its earnings come from proprietary trading. But the firm says its top executives in New York are supervising proprietary traders more closely, even as those traders are being allowed to invest larger sums. Mr. Siva-Jothy and his team in London focus on heavily traded markets, such as currencies, in which investors can quickly sell off their positions if they turn into losers. Dramatic movements in certain markets -- the fall of the dollar and of interest rates, for example -- have presented chances for nimble traders to profit. "Our risk appetite is somewhat higher this year because there have been better opportunities," says David Viniar, Goldman's chief financial officer.
Even within Goldman, though, some senior people worry that it may be time to exercise more caution. In September, Goldman Vice Chairman Lloyd Blankfein pulled up a chair next to Mr. Gerhard's spot on the cramped trading floor in New York and warned the trading executive, "This can't go on," according to someone who was there. The vice chairman added, "I don't want anyone going nuts" with risky bets.
Mr. Siva-Jothy, 39 years old, has emerged as a central player at Goldman by winning those bets this year. Bespectacled and almost bookish in his office manner, colleagues say he places trades in a soft voice to avoid attention on Goldman's competitive trading floor in London. Outside of work, he has a flashy side. During the summer, he spends time at Eilean Righ, a remote Scottish island he bought in 1999, often piloting one of his three helicopters to London. He recently purchased another home in Italy.
On Sept. 11, 2001, after terrorists flew the first of two passenger jets into the World Trade Center, Mr. Siva-Jothy, who was on the London trading floor, immediately turned to a colleague and said the disaster hadn't been an accident, according to people familiar with the comment. The weather in New York was clear, and the crash was purposeful, he reasoned. Mr. Siva-Jothy instantly began closing out trading positions that would fall in the wake of major terrorism. He quickly bought options that gave him the right to acquire government bonds at a set price in the future. As news of the attacks spread, other investors fled to the relatively safe haven of bonds, driving up prices and allowing Mr. Siva-Jothy to profit handsomely.
Late last year, when many investors thought interest rates would rise because of an improving U.S. economy, Mr. Siva-Jothy, Mr. Gerhard and others at Goldman bet that prospects were a little cloudier and rates would stay low or even tumble. The Goldman traders eventually made more than $100 million on that wager. This spring, Mr. Siva-Jothy's team made as much as another $100 million, playing its hunch that the value of the euro would jump against the U.S. dollar and other currencies.
On Nov. 6, traders crowded around the television on the Goldman trading floor in London to get word of the U.S. Federal Reserve's interest-rate deliberations. The team had been making investments that would pay off if there were a big rate cut. They cheered at 7:15 p.m. London time, when news outlets announced a half-point cut -- twice as large as most analysts had predicted. Goldman took in about $70 million, yet another score that would boost the firm's profits and traders' annual bonuses.
All told, Mr. Siva-Jothy's team of about a dozen has notched gains of about $500 million so far this year, according to people familiar with the matter. Geoffrey Grant, 42, one of the group's managers who also trades, is up about $150 million, giving the group combined gains of more than $600 million, the people say.
The team's daily profit or loss figure has been as large as $50 million, according to a person who has seen the results. Just three years ago such swings were rarely more than $10 million, this person says.
In the past, Goldman, like its rivals, has suffered striking trading losses. In 1998, it lost more than $650 million -- mostly from proprietary trading -- after Russia defaulted on its debt, roiling world markets. The firm lost about $250 million in 1994, when Goldman didn't anticipate interest rates shooting up.
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Although there are no exact gauges of trading risk on Wall Street, the most commonly used barometer is "value at risk," a figure that firms tend to calculate differently but that is supposed to measure how much money can potentially be lost due to bad market conditions and the likelihood of such losses happening. Goldman has reported in federal regulatory filings that the average sum it could lose on any given day, firmwide, grew to $47 million in the third quarter of this year. The figure has been rising since the fourth quarter of 2000, when it stood at $25 million. Even for a big Wall Street firm, $47 million a day would soon begin to sting.
Frightened Investors
The increased risk has frightened some Goldman investors. "It is never too much until it blows up," says Anton Schutz, a portfolio manager at Burnham Financial Services, which has $67 million in assets. Over the past year, he reduced his firm's position in Goldman shares by half, to 0.5% of his portfolio, and in November, sold his remaining position. In large part, he was motivated by anxiety over proprietary trading. "You have to look at their track record, and they are winning, but I can see the risk, which is why we are completely out now," Mr. Schutz says.
He isn't the only one. So far this year, Goldman stock is down 19.6%, compared with a drop of 16.8% for the Dow Jones Financial Services index.
But some investors in Goldman stock are backing the aggressive proprietary trading as a savvy short-term approach until investment banking and other areas pick up again. "We feel pretty strongly that Goldman Sachs is a well-run firm with great risk-management practices," says Michael Holton, manager of a financial-services fund at T.Rowe Price Group Inc. which owns 1.7 million shares of Goldman.
Like many sophisticated traders, Mr. Siva-Jothy uses options to boost the size of his bets, according to people familiar with the trades. Options are contracts that give investors the right, though not the obligation, to purchase certain securities at a set price by a certain date. Options cost a fraction of the underlying securitiy and can become significantly profitable if the security moves in price but the can become worthless is the investor has predicted incorrectly.
Overall, Mr. Siva-Jothy alone has generated between $70 million and $80 million of gains for Goldman so far this year, according to people close to his team. That could set him up for a payday of more than $10 million, according to these people. Traders on his team generally take home about 10% of the gains they make for the firm, but Mr. Siva-Jothy can expect even more because of the leadership role he is playing. Goldman is expected to announce bonuses Tuesday.
Mr. Siva-Jothy sometimes works in his spacious London office, which features stylish black modern Italian furniture. But he and his team, while constantly monitoring the markets electronically, sometimes don't come in at all, especially when they are sitting on gains. Andrew Law, another star trader, sometimes takes an hour or so out of the day to swim laps at a local pool, people who know him say.
Even the hot hands have had cold periods recently. Mr. Gerhard and others lost about $80 million over several days in mid-November 2001, when U.S. bond-futures contracts plunged in value. The losses caused grumbling among other traders at the firm, who say their 2001 bonuses were cut as a result.
But in the end, Mr. Gerhard's bet on U.S. bonds paid off for the firm -- and for him. He and a friend spent a total of $20 million in January to purchase the exclusive 215-acre Due Process Golf Course in Colts Neck, N.J.
Some Goldman traders have had to be prodded more than others to swing for the fences. Mr. Law was making consistent gains in the late 1990s but seemed reluctant to make bigger bets, according to people familiar with the situation. In 1999, a senior Goldman executive stepped up the pressure, telling Mr. Siva-Jothy he had to tell his colleague to take more risk, according to a person at the meeting. Eventually, Mr. Law, who is in his mid-30s, complied. Today, he is one of the London team's most successful traders. Mr. Law didn't respond to phone and e-mail messages seeking comment.
Other Goldman groups also are making big trades with the house's money, including a large team in New York that invests in securities of companies in pending mergers, among other things. Its profits have been about $200 million this year. Even Goldman bond, currency and commodity traders who fill orders for customers routinely make bets for the firm, according to people familiar with the situation.
In some ways, Goldman's trading bent isn't surprising. A number of the firm's senior executives, including Messrs. Gerhard and Blankfein, were hired not by Goldman, but by J. Aron & Co., a tiny but highly profitable commodities-trading shop known for its aggressive ways, which Goldman bought in 1981.
Legendary Traders
Though Goldman's current chief executive, Henry Paulson Jr., made his mark as an investment banker, some of his recent predecessors were legendary traders. Before becoming a U.S. senator, Jon Corzine was Goldman's CEO from 1995 to 1999. He got his start in 1975 as a bond trader, and senior executives still regale visitors with stories of his prowess trading the 30-year bond.
Top Goldman officials say they maintain closer supervision of proprietary trading than they did when the firm suffered its big losses in 1998. People familiar with the trades of the Siva-Jothy group say it systematically invests in different markets and uses varying strategies -- balancing long-term investments against short term, for example -- so that a single bad move won't cripple the firm. While other Wall Street firms have lost big money lending to telecommunications and energy companies in the past year, Goldman has avoided those hazards by focusing on trading, a business it has specialized in for years.
Still, some Goldman investors are worried. The overall "short" position in Goldman's stock -- which indicates the number of shares investors are trading with the hope of profiting from a stock drop -- has nearly tripled, to 15.9 million for the month that ended Nov. 15, up from 5.9 million six months earlier, according to the Nasdaq Stock Market, which compiles these statistics.
One recent seller is Bob Wiley. The portfolio manager for Seattle-based Sound Capital Partners dumped 225,000 shares of Goldman, or 2% of his portfolio, in late August. Mr. Wiley says his move wasn't tied to Goldman's proprietary-trading operations, but he adds that the strategy concerns him. "We want a comfort level the issue has been resolved before we buy back in," he says. |
