(Bloomberg) -- Morgan Stanley and Goldman Sachs Group Inc. led Wall Street banks in posting a collective 42% increase in equities-trading revenue in the second quarter, the largest jump in more than three years.

Morgan Stanley posted $1.81 billion of revenue from trading stocks and equity derivatives and providing prime-brokerage services, surpassing Goldman Sachs to top all rivals for the first time in at least two years. Revenue in New York-based Citigroup Inc.’s business climbed the most, with a 68% jump from last year’s second quarter.

Equities-trading revenue at the largest global banks slid for a third straight year in 2012 as volume declined and investors pulled more than $300 billion out of stock mutual funds, according to fund data from the Investment Company Institute and trading figures from Coalition Ltd. Rising interest rates may push more investors from bonds into equities, as inflows into stock funds were positive during the first five months of this year, the ICI data show.

“If you look at equities performance by region and product, it was very strong,” Morgan Stanley Chief Executive Officer James Gorman, 55, said in a Bloomberg Television interview yesterday with Erik Schatzker. “It’s been a business that has been doing great for a long time, but it had an absolute blowout.”

Combined Revenue

The five largest Wall Street banks posted equities-trading revenue of $7.01 billion, the highest second-quarter figure since 2009. Equities, which account for about a fourth of total trading and investment-banking revenue, include commissions and gains from buying and selling stocks, futures, options and other equity derivatives, as well as fees and interest income from providing services and lending to hedge funds.

Bank of America Corp.’s unit, led by Fabrizio Gallo, posted revenue of $1.19 billion, its highest since the first quarter of 2011. CEO Brian T. Moynihan, 53, cited that as evidence the Charlotte, North Carolina-based bank had “rebuilt that business.”

Goldman Sachs’s unit had $1.77 billion, excluding revenue from a reinsurance business the New York-based firm sold during the quarter, a 24% increase from a year earlier. The unit is led by R. Martin Chavez, Michael D. Daffey and Paul M. Russo. New York-based JPMorgan Chase & Co., whose equities trading is run by Tim Throsby, also posted a 24% jump to $1.3 billion. Citigroup’s unit led by Derek Bandeen had $942 million in revenue, the least among U.S. peers.

S&P Records

The Standard & Poor’s 500 Index climbed 2.4% in the quarter. The index hit a record high in May before dropping 4.8% over four business days in June after Federal Reserve Chairman Ben S. Bernanke indicated the central bank might taper its $85 billion in monthly bond purchases, which have boosted demand for higher-yielding assets. The index rallied again this month, closing at another record yesterday.

“Everybody keeps talking about the rotation out of fixed income into equities,” Goldman Sachs Chief Financial Officer Harvey Schwartz, 49, told analysts on a conference call. “Who knows how that will play out over the next decade, but certainly a lot of activity in equities space, particularly in Asia.”

Morgan Stanley also took advantage of increased trading in Japan, where it has two joint ventures with that nation’s largest bank, Mitsubishi UFJ Financial Group Inc. Morgan Stanley was the top broker on the Tokyo Stock Exchange in May and June, the first time it has held that rank in 15 years, said Ted Pick, the New York-based firm’s global head of equities.

That came as volume on the Nikkei 225 Index more than doubled in the second quarter from a year earlier, according to data compiled by Bloomberg.

Citing Performance

All five U.S. banks cited improved performance in equity derivatives. The Chicago Board Options Exchange Volatility Index, which measures the cost of protecting against swings on the S&P 500, averaged 14.84 in the quarter, down from 20.04 a year earlier.

The revenue rebound came without an increase in U.S. volumes. Average daily volume for U.S. equities was 6.58 billion shares in the quarter, down 3.5% from a year earlier, according to data compiled by Bloomberg. Trading may pick up if investors focus more on putting money in individual stocks rather than trying to make broader bets on indexes, Pick said.

“Renewed confidence engenders investor activity,” said Pick, 44. “The combination of earnings momentum and accommodation provide, not surprisingly, a continuing positive bias to the U.S. equities market.”

The one-third drop in U.S. volume from 2009 to 2012 helped push some banks out of cash equities, the trading of common shares on public exchanges. Royal Bank of Scotland Group Plc exited that unit last year, and Nomura Holdings Inc. folded cash equities outside Japan into its Instinet unit, the brokerage it acquired in 2006.

The survivors aren’t relying on an increase in trading.

“We are obsessed with returns-based metrics,” Pick said. “We offer a platform in which the cash product, in isolation, has a cost-to-income ratio well below 100%. At lower volumes we have generated acceptable returns through the cycle.”

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