At Caffe Vivaldi in New York’s Greenwich Village, Peter Muller bangs out a repertoire full of Carole King riffs on the piano along with his own soft-rock compositions that draw on the likes of Van Morrison and Cat Stevens.
“It’s not the same anymore,” he croons. “I’m still looking for my home.”
In the audience, couples sip house cabernet and applaud politely. Some drop $10 tips into a metal bucket.
About 40 blocks uptown, in a 42-story skyscraper overlooking Duffy Square, the straw-haired Muller, 47, performs for a tougher crowd — as the multimillionaire math whiz behind one of Wall Street’s most secretive trading machines.
Muller is the founder of Morgan Stanley’s Process Driven Trading group, or PDT, a 70-person band of PhDs and computer jockeys. They use algorithm-rich programs to bet Morgan Stanley’s money on pricing discrepancies in global markets.
With no outside investors to please, Muller has kept the strategies and performance of PDT under wraps, stoking the curiosity and envy of rivals.
“They say: ‘I know him. He made a boatload of money for Morgan Stanley,’ ” says Arjun Divecha, chairman of Boston-based GMO, who manages about $18 billion using quantitative techniques. “They don’t know how he’s done it.”
Muller makes no apologies for his obsessive secrecy.
“I want my competitors to know absolutely nothing about what we do,” Muller says in his corner office, which is decorated with pictures of his wife, Jillian, and their two children as well as a pair of battered snowboards.
A troubadour, yoga enthusiast and math geek, Muller makes an unlikely Morgan Stanley executive. The 5-foot-10-inch, 160-pound manager practices ashtanga yoga, a style that incorporates synchronized breathing. He’s also a champion Texas Hold ’Em poker player and writes New York Times crossword puzzles several times a year.
Since he started PDT in 1993, its investments have returned an estimated annual average of more than 20 percent through 2010, according to a person close to the group. As a proprietary-trading desk, PDT uses different accounting rules than hedge funds. Its return figure has been adjusted to approximate its performance as if it were a hedge fund.
Hedge funds on average gained 10.4 percent annualized, net of fees, from July 1, 1993, through 2010, according to Chicago-based Hedge Fund Research.
After almost two decades at Morgan Stanley, Muller is about to go out on his own, a move precipitated by the biggest regulatory overhaul of Wall Street since the Great Depression. Banks are jettisoning or closing groups like PDT as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in 2010.
The law’s Volcker rule, named for former Fed chairman Paul Volcker, bars banks from maintaining prop-trading operations and restricts the amount they can invest in hedge and private equity funds to 3 percent of their tier 1 capital. They can also own no more than 3 percent of such funds.
In its 2010 annual report, Goldman Sachs disclosed it had liquidated most of its long-short prop desk positions and was doing the same with its global macro group. Morgan Stanley in March completed the spinning off of FrontPoint Partners, a hedge fund it acquired in 2006. Bank of America disclosed in April a plan to sell its main private-equity business to management.
Now, it’s PDT’s turn. In January, Morgan Stanley said it would spin off the group at the end of 2012 as a separate firm. Morgan Stanley retained an option to buy a preferred stock position in the new company for undisclosed terms.
Cutting risk — and perhaps return
For decades, prop desks have played a crucial role in the transformation of investment banks such as Morgan Stanley from advisory and underwriting businesses to trading powerhouses that bet huge amounts of their own firms’ money. Once the closely held Wall Street partnerships began tapping the public markets for capital, prop desks could wager with shareholders’ money.
By the mid-2000s, prop traders were at the center of the exploding markets for collateralized debt obligations, or pools of bonds, and derivatives, which are instruments that derive their value from an underlying asset. These products were high-octane fuel for the credit bubble that ultimately blew up Bear Stearns, Lehman Brothers and AIG.
As the curtain falls on prop trading at banks, their profits may suffer. Morgan Stanley in 2008 began to pull back on risk, partly by reducing leverage. Since then, its fixed-income trading revenue has been sluggish. Morgan Stanley’s net income fell 45 percent in the first quarter of 2011 from $1.78 billion a year earlier. While firms don’t generally disclose profits from prop trading, Goldman characterized it in 2010 as constituting about 10 percent of revenue in most years.
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