Participants
CB, Clifford Chance The nature of prime brokerage has changed, as has its profitability and relevance to the institutions. What are the core services prime brokers must offer today to stay competitive?
MB, Barcap A prime broker acts as a centralized clearer and custodian to a hedge fund’s assets. The prime broker uses the assets as collateral to make loans of money, equities and/or bonds to the fund. The size of the loan extended depends upon the quality of the collateral and the risk associated with the entirety of the fund’s portfolio. The more sophisticated investment banks are increasingly able to incorporate derivatives and other products into the risk calculation. That is the core service. Prime Services at Barclays Capital is a multi-asset financing business with customers able to choose to finance via prime brokerage, CFDs, swaps or repo.
JB, Dresdner Kleinwort The prime broker is a facilitator who assists increasingly sophisticated clients in fulfilling their investment strategy. Clients are turning to complex strategies and structures in order to generate higher returns and thus differentiate themselves. Dresdner Kleinwort will finance most asset classes via bespoke financing solutions and offers true cross-margining.
DP, Merrill Lynch There are certain core functions prime brokers have to perform well to ensure the operational efficiency of a hedge fund, but to us it’s also about helping the client across all their activities, including alpha generation. It’s about giving colour on the stock loan market to help portfolio timing decisions, giving transparency on what the free float is, for example. Equally importantly, we provide access to the research capabilities and resources of the rest of the bank. Our consulting side of prime brokerage helps clients run and develop their business, with capital introduction as a key function in planning business development in terms of asset growth.
AL, Man We see prime brokers as solutions providers. We have a huge managed account platform and we rely on prime brokers for clearing solutions, for the right technology, for global presence and so on. When we can step out of traditional prime brokerage, we start looking at ways to cross-sell one another’s firms, to people we look to partner with long- term, whether it’s dealing a structured finance platform, FX or distribution.
CB, Clifford Chance As the market institutionalizes, though, will those commoditized clearing services become less important and the more value-added services more important?
MB, Barcap The industry is certainly becoming much more institutional. In the US now, there are around 210 groups running $850 billion, so that’s less than 5% of the fund management groups running around 65% of the assets. In Europe about 12% of the groups run two-thirds of the assets. That relatively small number of increasingly institutional asset management organizations is the battleground for prime brokers. The challenge for some of the prime brokers is that they built their business models for a less mature industry, where everyone was a start-up, and there was far less information available about who the investors were. Today the industry looks very different.
DP, Merrill Lynch Four or five years ago, the traditional prime brokers would not want to service, say, an emerging markets credit fund because they had enough money coming from the plain vanilla equity long/short business. Now more innovative prime brokers will do the more complex business as a way to get their foot in the door. That has been a very positive thing for hedge fund investors. Whereas seven or eight years ago only two prime brokers in Europe could deliver effectively, now there are at least six.
CT, New Star We should point out that the three clients of prime brokerage here have particular requirements. We are the bigger players, but many people in the hedge fund industry have one fund which is specialist in one area. Their requirements from the prime broker are narrow and the interactions and cross-selling are not material for them. It’s a very basic, commoditized, clearing service for many people.
CB, Clifford Chance So is there still room for the smaller start-up and will that start-up get the services they need from the prime brokerage community?
MB, Barcap The talented boutique fund manager starting with a small amount of capital is statistically less likely to succeed than he would have been in 1999 and less likely to succeed by himself rather than, say, being under Gartmore’s platform. So focusing on the bigger hedge fund organizations with multiple funds may be a better use of a prime broker’s resources.
CT, New Star There’s nothing new in this. In the 1990s if you were the biggest fund manager you would always get the first telephone call and the best service from the equity sales person. The prime brokerage business is exactly the same. The bigger you are, the more money you can pay and therefore the better the service. An add-on service is not commoditized because, by definition, you can’t offer it to everybody, and the prime broker provides the big guys with different services from the small guys.
DP, Merrill Lynch I think there is still a place for the new, entrepreneurial start-up, but they’re more savvy. When a hedge fund awards their PB mandate, they’ll have questions like, “What do I get from your capital introduction team? Will I go to your big annual conference? Will I get a roadshow in Geneva? Who’s going to be my dedicated capital introduction person? Will I get help from your start-up services team? What coverage am I going to get from the research sales team?” A big institution will get all that attention by definition – the alpha generation ideas and so on – but it’s even more critically important that the boutique start-up gets the support that will allow it to build a sustainable business model.