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PAY NO ATTENTION TO THE ARB BEHIND THE CURTAIN

In the heady days of the 1980s, John Meriwether and his band of arbitrage traders operated in the midst of the action at Salomon Brothers Inc.--the firm's cavernous lower Manhattan bond-trading floor. Today, Meriwether is long gone, and Salomon's famed ''arb group'' has new digs: a bland, quiet office packed with computers, seven floors removed from the bustle of customer business.

Even shuffled off to the side, the arb group remains Salomon's core. It has 26 people in New York working on complex trades, with 84 in London and Tokyo, all under London-based Shigeru Myojin. Its profits are the firm's crowning glory--and, ironically, one of its biggest impediments. The past two years have been especially strong for Salomon's in-house wizards, say market sources, and Solly still devotes about half its $5.8 billion in equity capital to the arb group. But while big winnings have bolstered the firm for years, the results have hurt its credit rating and stock market valuation because they're impossible to forecast.

NO NUMBERS. That's one reason Solly's brass would rather talk about its more predictable customer businesses and downplay its proprietary riches. Salomon has stopped breaking down quarterly revenues into proprietary and customer businesses. It last disclosed its segmented results in the third quarter of 1995, after proprietary trading accounted for nearly all its earnings in the previous nine months. While surely atypical, pretax income in that period was $495 million for proprietary and only $2 million for client business. In part to even out the numbers, Salomon has cut risk-tolerance levels by a third since 1994, says ceo Deryck C. Maughan: ''If we run the place with too much risk, the quarterly volatility begins to disturb people.''

For years, customers wondered whether there were conflicts in allowing Solly's house traders to operate in the same arena with Solly employees working for customers' interests: Did the arb group's location allow it to front-run customer orders? And morale was strained, former insiders say, by having arb group leaders who earned $30 million a year sitting next to client traders making about one-fortieth of that.

For his part, New York arb chief Robert M. Stavis says he's happy with the change of scenery, which put together for the first time his research and trading staffs. The boyish-looking 34-year-old, who trained under Meriwether, says his team mainly bets that out-of-whack prices will return to equilibrium over time, a technique called ''convergence'' or ''relative-value'' trading. Salomon is known for making longer-term trades--an average of nine months for a single transaction--and placing bigger bets than competitors.

In spite of risk reduction, those bets are still skewing Salomon's results. While the firm boosted headcount overseas in 1996, European and Asian revenues from continuing operations stood at 32%, down from 47% in 1995. Why? Probably because Solly's Asian and European proprietary traders' results were off. As goes the arb group, so goes the firm.

By Greg Burns in New York


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Updated June 15, 1997 by bwwebmaster
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