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Capital Markets

Hedge funds and prime brokers: A rocky patch in a marriage of convenience

The liquidity crunch of August and September highlighted the intricate relationship between prime brokers and their hedge fund clients. Some managers had their livelihoods threatened by increased margin requirements, while asset valuations were brought into question. Do the two sides of the relationship know each other at all? Helen Avery reports.

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IT OUGHT TO be a symbiotic relationship. "Prime brokers need hedge funds, and hedge funds need prime brokers. They may moan about each other, but it’s a marriage and it works," says an Asia-based hedge fund manager. "But this summer’s events underlined again the issues of liquidity and valuation, and some of the partners in those marriages were left wondering just how much they knew about each other after all."

As sub-prime mortgage-backed securities took a dive early in the summer, multi-strategy funds were forced to sell off their most liquid assets in order to post collateral to meet their prime brokers’ terms. It resulted in a steep drop in the equity market as positions were sold, and equity-related hedge funds in turn had to sell off sharply to meet their margin requirements. Other hedge funds that had large sub-prime mortgage exposure saw collateral seized, and valuations were slashed with some dubious calculations; a handful of funds were forced to close their doors. Hedge fund firms that had exposure to these hard to value CDOs are still battling with how to value their portfolios, and halting investors from leaving.

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