We are entering a period of fundamental change for hedge funds. This is true not only for investors and managers but also for key service providers such as prime brokers.
This was made dramatically evident in March with the last-ditch rescue by JPMorgan of Bear Stearns – for many years among the top-three prime brokers in the US. At the time, ironically, Absolute Return was getting started on its first-ever research project attempting to measure market share among prime brokers in the US.
Not surprisingly, our data team was suddenly inundated with messages from funds using Bear Stearns as prime broker. Some said they were ditching Bear in favour of other firms; others that they were staying with Bear but adding other PBs to their roster; and others said that they were staying with Bear alone – now it was backed by the financial might of JPMorgan. Amid the confusion, we felt there was no choice but to delay our research and wait until the dust settled.
Outside the US, where EuroHedge and AsiaHedge have routinely conducted market share surveys for several years on prime brokers in Europe and Asia, we did not feel there was such a problem. Having conducted those surveys before, we knew Bear Stearns had never built a big PB business in Europe, and still less in Asia – so we could do those surveys as normal.
While the US reputedly always had three leading players – Morgan Stanley, Goldman Sachs and Bear Stearns – the European survey has typically shown two firms clear of the field – Morgan Stanley and Goldman Sachs. The top two have been closely matched by number of fund mandates – with Morgan on 404 as against Goldman on 383, according to our latest survey. Measured by assets under management of funds served (with shares of split mandates divided evenly unless managers stipulate otherwise) Morgan has been much further ahead – with a figure of more than $145 billion on the latest survey as against just under $90 billion for Goldman.
The European survey arguably exaggerates the extent of Morgan Stanley’s lead, given it is mainly based on long/short equity funds that typically use little leverage – as compared with multi-strategy, macro and other funds where market share is more evenly spread across the Street. But Morgan has clearly had the benefit in Europe of first-mover advantage, with that lead by assets built on retaining the lion’s share of business with long-established clients such as Egerton, Lansdowne and Sloane Robinson.
In Asia, it has been a similar story – with the same two firms ahead of the pack. But there it was Goldman Sachs that enjoyed first-mover advantage – in Japan, which was for many years by far the biggest part of the Asian market.
Goldman still has the edge in Asia overall by number of mandates, with 223 on our latest survey against 205 for Morgan. By assets, Morgan Stanley is ahead in Asia too – with nearly $54 billion as against $41 billion for Goldman – having done better with the faster-growing ex-Japan funds in the past couple of years.
One of the most striking things about both surveys is how well the top two have done to retain such strong market shares – with well over 40% between them of assets in Europe and nearly 60% in Asia. In future, though, various factors seem certain to make the challenge of staying ahead tougher than ever for the top two.
The Bear collapse had little direct impact in Europe or Asia but it emphasized to hedge fund managers everywhere the counterparty risk of maintaining only one PB relationship. Investors are now pressing managers to go multi-PB. And where, in previous years, a Morgan client might well have chosen Goldman as a second PB, and vice-versa, that might not happen so readily in future. If you already have one US broker-dealer as a prime broker, would you really diversify your risk by adding another one?
There is no shortage of competition from other firms in core PB services such as stock loan, equity finance and capital introduction. Competitors include Lehman Brothers and Merrill Lynch, both with areas of strength. But arguably, it is the big commercial banks – with more direct access to funding – that might be better placed, including Citi, which has already developed a PB capability, and JP Morgan, which has just acquired one.
Internationally, UBS is the closest competitor by both mandates and assets in Europe and in Asia – having grown dramatically ever since Alex Ehrlich moved across from Goldman Sachs to spearhead the effort in 2003. Whether UBS can continue to expand so aggressively remains to be seen, however, after such huge credit-related write-downs.
If existing Morgan and Goldman clients start to prefer commercial or universal banks as second or third PBs, then those best placed to benefit most might well be the next two biggest players – Deutsche Bank and Credit Suisse. Both have already grown their PB businesses in Europe and Asia over the past two years.
That said, PB remains a market of many niches. So there will be opportunities for others. These include Newedge, which focuses on managed futures, volatility trading and macro – all areas where funds have done well over the past year – and Barclays Capital, with a strategy based on cost efficiency through cross-product netting, which often does not rely on an official PB mandate. And there is BNP Paribas, following its acquisition of the Bank of America business.