Goldman Profited on its Trades, Clients Lost on its Advice

Photographer: JB Reed/Bloomberg

Goldman Sachs Group Inc.'s headquarters building in New York. Close

Goldman Sachs Group Inc.'s headquarters building in New York.

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Photographer: JB Reed/Bloomberg

Goldman Sachs Group Inc.'s headquarters building in New York.

Goldman Sachs Group Inc. racked up trading profits for itself every day last quarter. Clients who followed the firm’s investment advice fared far worse.

Seven of the investment bank’s nine “recommended top trades for 2010” have been money losers for investors who adopted the New York-based firm’s advice, according to data compiled by Bloomberg from a Goldman Sachs research note sent yesterday. Clients who used the tips lost 14 percent buying the Polish zloty versus the Japanese yen, 9.4 percent buying Chinese stocks in Hong Kong and 9.8 percent trading the British pound against the New Zealand dollar.

The struggles for analysts at Goldman Sachs, which is fighting a fraud lawsuit from U.S. regulators who accuse the company of misleading investors in a mortgage-linked security, show the difficulty of predicting market movements as widening budget deficits, a fragile global economic recovery and tighter financial regulations increase volatility. Stock and currency fluctuations rose to the highest in a year this month as Europe pledged about $1 trillion to stop a debt crisis in the region.

“This says that Goldman’s guys are only human,” said Axel Merk, who oversees $500 million as president and chief investment officer of Merk Investments LLC in Palo Alto, California. “No one is always right. There are a lot of cross currents in this market.”

Gia Moron, a spokeswoman for Goldman Sachs, declined to comment.

China’s Bear Market

Goldman Sachs’s trading profits come from capturing bid- offer spreads when its traders act as intermediaries for clients, Gary Cohn, the firm’s president and chief operating officer, said last week in New York. Proprietary trading isn’t a main driver of earnings, he said.

The trade advice for customers is distributed by Goldman Sachs’s global markets economic research group. It tracks the performance of the trades in a daily research note. The time period of the recommendations is 12 months.

The performance this year is a reversal from 2009, when nine of Goldman Sachs’s 11 trading recommendations made money. Investors saw a 22 percent return owning Chinese stocks and a 12 percent gain buying the British pound versus the dollar, according to a Goldman Sachs note on Dec. 1.

Goldman Sachs analysts made eight trade recommendations for this year in December, including telling clients to buy the British pound against the New Zealand dollar. On April 1, Goldman Sachs added a ninth “top” trade, telling clients to buy Chinese stocks listed in Hong Kong and predicting the Hang Seng China Enterprises Index would rise 19 percent to 15,000.

Tough Analysis

Since then, the gauge has slid 9.4 percent to 11,426.18. The Shanghai Composite index has entered a bear market, losing about 21 percent this year. That’s the third biggest decline in the world after Greece and Cyprus. The decline accelerated this month on concern Greece, Spain and Portugal will struggle to finance their budget deficits and dismantle the euro.

The Chinese stock recommendation was made by a group led by Dominic Wilson, a senior Goldman Sachs economist in New York. Wilson cited inexpensive valuations and “robust” economic growth. He also said investors have already factored in the risk of higher interest rates in China.

Wilson wasn’t available to comment because he was out of the office traveling, according to an e-mail.

Exit Calls

“Emerging markets appear superior to the developed world, but the market isn’t trading that relationship,” said Eric Fine, who manages Van Eck Associates Corp.’s G-175 Strategies emerging-market hedge fund. “It may be that some assets are mispriced, but if the market starts to discount the end point of the game, such as the collapse of the euro, it’s not that mispriced.”

Analysts at Goldman Sachs recommended investors exit two trades in February, one involving interest-rate swap rates in the U.K. and another advising clients to buy credit-default swaps in Spain and sell similar contracts in Ireland. The first trade had a potential loss of 24 basis points and the other had a return of 2.9 percent, according to figures issued in the appendix of the research note in February.

Owning currencies that are tied to growth is the only remaining trade that has increased in value this year, according to Goldman Sachs. The Goldman Sachs FX Growth Index has climbed 3.4 percent since the firm made the recommendation in December.

Betting on Markets

Goldman Sachs makes more money from trading than any other Wall Street firm. In the first quarter, the bank’s $7.39 billion in revenue from trading fixed-income, currencies and commodities dwarfed the $5.52 billion made by its closest rival, Charlotte, North Carolina-based Bank of America Corp. In equities, Goldman Sachs’s $2.35 billion in revenue was about 50 percent higher than its nearest competitor.

Cohn told investors at a May 11 conference in New York that the firm lost money on only 11 days in the last 12 months. He said that uncanny streak of success refutes suspicions that the bank depends on proprietary bets with its own money.

“It is implausible that a proprietary-driven business model could be right 96 percent of the time,” Cohn said. Instead, he said the “simple answer” is that the firm makes money by capturing bid-offer spreads when acting as an intermediary for client trades.

Goldman Sachs executives have grappled before with questions about whether they’re better at making money for the firm than for their clients, according to an internal e-mail dated Sept. 26, 2007, that was released by a U.S. Senate subcommittee last month.

U.S. Lawsuit

The e-mail to Chief Executive Officer Lloyd Blankfein from Peter Kraus, who was then co-head of the company’s investment- management division, explains that individual investors, unlike institutional clients, occasionally make “comments like ur good at making money for urself but not us.”

The U.S. Securities and Exchange Commission filed a lawsuit against Goldman on April 16 accusing the company of misleading investors in a mortgage-linked asset. Goldman denies those allegations and said it will fight the charges.

To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net.

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