Hedge Fund Growth and Competition Among Prime Brokers Triggers Wave of Hiring
An increasing number of hedge funds are using multiple prime brokers for their trading, borrowing and portfolio-monitoring needs. Now as the hedge fund industry grows, banks may finally be warming up to the idea of a multi-prime world. A new study suggests that prime brokers are adapting their business models to accommodate hedge funds seeking multiple prime brokerage relationships. As a result, competition between prime brokerages remains fierce along with demand for top talent. According to executive recruiting firm, A.E. Feldman, salespeople, marketing professionals and portfolio risk managers are in short supply.
The number of hedge funds has grown dramatically, from about fifty in the ’80s to more than nine thousand today. This year the industry saw inflows of more than $60 billion in the first quarter, bringing total assets under management to $1.6 trillion,according to data released by Chicago-based Hedge Fund Research, Inc. This growth has spurred demand for prime brokerage services at all points of the hedge fund life cycle.
Prime-brokerage firms were developed in the early ’80s to help fund managers keep track of transactions and positions through a central account. Today, prime brokers have become indispensable partners in hedge funds’ strategy for success, offering a slew of technologies and services. The firms traditionally provide hedge funds with the financing they need to execute trading strategies, clear trades, custody securities, provide margin financing, lend stocks to cover short sales, and provide cash and position reports. In return, prime brokers collect hefty interest income. Essentially, prime brokerage has become a lucrative business for many Wall Street firms.
Most prime-brokerage revenue comes from fees charged on stock loans and financing. Trading commissions are another source of income. Total revenue from prime-brokerage operations reached about $7.5 billion in 2005, according to estimates from Sanford C. Bernstein & Co. But the majority of hedge funds prefer to not have their execution and prime-brokerage services consolidated under one roof. Roughly 56% of hedge funds managing more than $1 billion in assets have more than four prime brokers, according to a 2005 survey by the Tabb Group, a financial-markets research and advisory firm. The smaller funds surveyed had up to three prime brokers. One primary reason why: price.
Different prime brokers bring different things to the table. Hedge funds can use multiple relationships to obtain better terms and rates, while limiting risk exposure to any one firm. Maintaining several prime-brokerage relationships may allow hedge fund managers to sleep better at night knowing that no one broker has records of all their investment positions and strategies.
Now, amid the vast proliferation of hedge funds, prime brokers are warming up to the idea of a “multi-prime world” in order to sustain the high level of profitability to which their parent investment banks have grown accustomed. That’s according to a recent study conducted by Paladyne Systems. The study also found that prime brokers would adapt their business models to accomodate this trend. “The introduction of technology that enables multi-prime broker relationships for hedge funds is changing the very business model under which prime brokers have operated to date,” said Sameer Shalaby, CEO of Paladyne Systems. “The next generation prime broker will be one that readily partners with both competitors and independent service providers to stay in-sync with the new forces shaping the hedge fund industry.”
Paladyne predicts that hedge funds will have an average of three prime brokerage relationships to support their trading and operational needs, up from an average of 1.9 today. The study also outlined a new prime broker business model with five key requirements including broker-neutral technology, independently-hosted technology, middle- and back-office services, fund administration and independent net asset valuation, and independent business consulting services.
“Hedge funds are already rejecting the traditional captive service model in which prime brokers, offering selective services, effectively handcuff their single-prime clients,” says Shalaby. Established and even start-up funds increasingly demand such services as multi-asset trading platforms, sophisticated risk systems, lower cost IT, global markets coverage, middle- and back- office outsourcing, and fund administration. Shalaby adds, “If you’re going to be managing $500 million and up you really need better operational infrastructure, technology, staff and compliance.”
Bottom line: hedge funds are looking for more from their prime brokers, which have become a major source of revenue for many leading investment banks. The growing demand placed on prime brokerage firms is not only causing a shift in the relationship between hedge funds and their prime brokers, it’s also triggering a wave of hiring. Carol Schwam, CEO of A.E. Feldman, says, “Prime brokers need salespeople, marketing professionals and portfolio risk managers. This area is really hot.”
Experienced portfolio risk managers are among those in greatest demand. According to Schwam however, candidates must be able to effectively interact with clients and work on client pitches. “The skill set is much wider.” Sales and marketing professionals are also in short supply. Previous experience in prime brokerages, equity derivatives and convertibles trading or risk management is essential. Candidates should also be well versed in equity and credit market risks and hedge fund trading strategies. Schwam also says a CFA is preferred over an MBA. “For anyone analyzing or monitoring a portfolio, CFA and FRM certifications are superb for credibility.”
