Just how are prime brokers going to make sure they are just that – a hedge fund’s prime broker? Competition is heating up among them as they make the startling discovery that hedge fund managers are not averse to using more than one prime broker at the same time [see Fund Management news, Hedge funds go outsourcing, this issue].
Now that hedge fund managers have squeezed prime brokerage fees, the only means of differentiation is levels of service, and managers are rightly prepared to shop around and use several specialists if need be. Furthermore, software companies have facilitated the cost-efficient and simple use of multiple brokers by managers.
As competition for new asset inflows grows, hedge funds are increasingly turning to prime brokers for capital introduction services. According to a survey by Greenwich Associates, the proportion of hedge funds citing capital introduction as an important factor in evaluating prime brokers has doubled from 7% to 14% since last year.
Financing and repo capabilities are also important criteria for selection. The pressure on dealers to meet hedge fund demands in this area and hold on to the lucrative fees they pay is obvious. Seventy per cent of dealers are accepting collateral of a lower credit quality than a year ago on their hedge fund repo business. Thirty-eight per cent of dealers now list sub-investment-grade bonds as the lowest quality of collateral that they accept, up from 11% in 2004.
But crucial to winning the battle for hedge fund money will be those prime brokers that are able to serve hedge funds with esoteric trading strategies. As opportunities become harder to find, hedge funds that eke out and exploit niche opportunities will be in the driving seat.
The inability of markets at the moment to offer services to cope with such esoteric trading strategies is hindering growth, many hedge fund managers observe, and pushing them into strategies traditionally dominated by banks, such as lending and financing. What they really want, they claim, is a prime broker that can sit alongside them and develop products and services that can allow them to do what they are in business to do – make money.
