Morgan Stanley's riskier trading operations have stolen the thunder from its growing brokerage -- at least for now.

Strong fixed income sales and trading revenue and improved investment banking underwriting results broke a three-quarter losing streak as Morgan Stanley belatedly joined rivals like Goldman Sachs Group Inc in returning to the black after the collapse of the financial sector a year ago.

The New York-based bank reported third quarter net income of $498 million, or 38 cents a share, beating analysts' average forecast of 27 cents a share, according to Thomson Reuters I/B/E/S.

Morgan Stanley shares closed up about 5 percent at $34.08 on the New York Stock Exchange after earlier touching a 13-month high of $35.

In the 2008 third quarter the bank earned $7.7 billion, or $7.38 a share, boosted by a one-time accounting gain from declines in the value of its debt.

Scarred by the collapse that claimed competitors like Lehman Brothers, Morgan Stanley has pledged to play a more conservative hand as it develops its brokerage business.

Co-president James Gorman is set to succeed Chief Executive John Mack -- credited with keeping the bank alive during the darkest days of the crisis, but criticized for struggling to manage risk -- early next year.

Many analysts view Gorman's appointment as evidence that Morgan Stanley is trying to dial down the riskier trading business in favor of a steadier stream of income from the wealth management business.

MAKING UP GROUND

Morgan Stanley Chief Financial Officer Colm Kelleher said in an interview that the third-quarter results were an affirmation that the firm's strategy was bearing fruit.

The third-quarter rebound came largely because of solid results in trading, a riskier area of the business.

They made up the ground on the trading side, said Brad Hintz, an analyst with Sanford C. Bernstein in New York and former treasurer at Morgan Stanley. The issue that Morgan Stanley faced is they cut too deeply in fixed income and markets came back more quickly than they anticipated.

Kelleher said during a call with analysts that the firm is about halfway through a hiring spree it initiated earlier this year to restock its trading and sales ranks. Kelleher said more than 400 were expected to be hired.

It is good that they are starting to see some of the early benefits of that, said Michael Hecht, an analyst with JMP Securities.

The firm's institutional securities group, which includes the advisory, underwriting and trading units, posted pre-tax income of $1.3 billion in the quarter.

Morgan Stanley increased its daily exposure to risk in the third quarter, upping its average value-at-risk on 95 percent of days to $118 million from $113 million in the second quarter. The biggest jump was in foreign exchange rate trading, which increased from $17 million to $25 million.

Morgan Stanley has been dogged by comparisons to chief rival Goldman Sachs over the past year. Goldman last week reported a $3 billion profit in another blockbuster quarter.

Goldman reported a value-at-risk on 95 percent of days of $208 million, well above Morgan Stanley.

Many people have beaten them up because they have not used leverage as expertly as someone like Goldman has, said Matt McCormick, a Cincinnati, Ohio-based portfolio manager with Bahl & Gaynor Investment Counsel, who does not own Morgan Stanley shares. They are not in the same camp as Goldman.

BONUS STASH GROWS

As Goldman rebounded, Morgan Stanley executives pleaded for patience as they bolstered their ranks on the trading side and integrated the Morgan Stanley Smith Barney joint venture, creating the world's largest brokerage.

Global Wealth Management, much bigger than a year ago as a result of the acquisition of Citigroup's Smith Barney brokerage business, had pre-tax income of $280 million, better than a year-ago loss but still dwarfed by investment banking.

At least for this quarter, the management strategy and the business model are working and the stock is reflecting that, said Michael Holland, president of Holland & Co in New York.

Integrating Morgan Stanley Smith Barney is still one of the biggest challenges facing the firm, analysts said.

The third-quarter results included an accounting loss of $900 million, or 36 cents a share, from a rise in the value of the firm's debt. Writing up debt caused a loss of $2.3 billion in the second quarter, while writing it down brought a whopping $9.7 billion gain in the year-ago quarter.

Morgan Stanley stashed away about $5 billion in the third quarter for year-end bonuses, lifting its bonus pool to $10.9 billion. Goldman has set aside nearly $17 billion so far.

Morgan Stanley's consolidated net revenue in the quarter fell 52 percent to $8.7 billion, reflecting the one-time accounting gains in the year-ago period.

Morgan Stanley is trying to turn around its asset management division, which posted losses totaling $2.64 billion in 2008 and the first half of 2009.

Earlier this week, Morgan Stanley said it was selling its mutual fund unit to Invesco Ltd for $1.5 billion as it looks to focus on higher-margin asset management. Morgan Stanley received $500 million in the deal, plus a 9.4 percent stake in Invesco.

(Reporting by Steve Eder; editing by John Wallace and Andre Grenon)

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