Prime Brokerage Poised for Gains, Evolving to Meet Demands
Goldman Sachs beat analysts’ estimates in the second quarter as gains in asset management and prime brokerage help to boost profits. The firm reports that net income dropped 11% percent to $2.09 billion in the three months ended May 30, surpassing expectations. Goldman Sachs’s prime brokerage and asset management divisions share some credit for that. Net revenue from securities services, which includes Goldman’s prime brokerage, jumped 29% to $985 million. Meanwhile, revenue from its asset management group, which includes its hedge funds, rose 10%. The firm says asset management hit record quarterly management and other fees of $1.5 billion. Additionally, Goldman says assets under management grew 18% to a record $895 billion.
Prime brokerage is expected to rake in $11 billion in hedge fund money this year, according to a study conducted by the TABB Group. That windfall is a 15% increase over 2006, the group says. The research also predicts that prime brokerage units will become banks’ most lucrative institutional business line within the next two years. Bloomberg quotes Stephen Brown, a Finance Professor at New York University’s Stern School of Business as saying, “Hedge funds are poised for another take off as the credit crisis eases, and prime brokers do well when hedge funds do well.” Amid the trend, executive search firm, A.E. Feldman, says the growing demands placed on prime brokers will likely create more financial jobs. Opportunities are emerging for account managers, portfolio risk managers, professionals with experience in capital introductions as well as salespeople and marketing professionals.
Prime Brokerage is Big Business
Industry experts project that as the hedge fund industry grows the importance of prime brokers and competition within the prime brokerage industry will increase.
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.
It is the goal of prime brokerages to offer hedge funds investment strategies and help them maximize their trading performance, build their business, and attract new sources of capital. Brokers collect fees for financing and executing trades, lending stocks, and keeping trading records. And banks that can provide hedge funds with an edge through technology, access to sophisticated financial instruments, and other services are increasingly rewarded with routine prime brokerage business.
According to TABB analysts, 86 large hedge funds, 336 medium hedge funds and 2,795 small hedge funds in the U.S. rely on prime brokers to clear trades, help finance their businesses and even find them investors. In short, prime brokerage is big business.
“Industry revenues generated from financing, stock loan, custody and other prime services will surpass other institutional business lines by 2010, in particular the cash equity business, which is hovering around $12 billion a year,” according to Tabb Group estimates.
Fierce Competition
With more than $11 billion in expected hedge fund revenues in 2008, competition among prime brokerage firms is fierce, according to FINAlternatives. The report states, “Nowhere is this more visible than among the industry’s top players. As bulge-bracket firms such as Citigroup and JPMorgan Chase make major pushes to build up their prime brokerage units and gain marketshare, their more established counterparts—Deutsche Bank, Morgan Stanley, Merrill Lynch and Goldman Sachs—are fighting to hold tight to their dominance of the industry.”
FINalternatives adds that large hedge fund firms, which are typically using multiple prime brokers, are becoming more and more demanding about the services they require. “They want prime brokerages that can not only provide them with state-of-the-art trade execution platforms, but real-time data on risk exposure and clearing information, as well as phone access to industry specialists,” the report states. Essentially, prime brokers are increasingly differentiating themselves through the breadth of services and level of expertise they provide.
The emphasis on risk is also a factor. FINAlternatives quotes John Quartararo, a Partner with San Francisco-based prime brokerage firm Merlin Securities, as saying, “One of the key driving forces behind change in the prime brokerage industry is the proliferation of the sophisticated institutional investor. Not only do these investors require greater transparency into funds, they insist that the funds step up their operations and infrastructure.” Quartararo adds, “Fund managers, in turn, look to their prime brokers to provide advanced attribution and risk analytics, as well as a suite of investment products and administrative services. The prime brokers that evolve on behalf of their client’s client will define and lead the industry.”
