Sponsored by Wells Fargo
The market for prime brokerage is not uniform. At one end of the spectrum are the largest hedge funds, which generally prioritise access to balance sheet and the comfort of dealing with a bulge bracket institution in the event of either a challenging macroeconomic environment or periodic balance sheet tightness – not, it should be said, a feature of the present market. At the same time, challenges in raising capital have made many funds of all sizes sensitive to the pricing of their counterparties’ services.
Against this backdrop, competition amongst some prime brokers remains intense for balances from fund managers whose AUM is in excess of $1 billion. Meanwhile, for smaller funds, there is relatively less competition across potential providers as a focus on cost efficiencies and minimum per-client revenue targets has caused some prime brokers to restrict their engagement with this segment. Given this new paradigm, prime brokerage has had to evolve from a back-office function that mainly cleared and financed trades – essentially operational activities – to include more front-end, client-facing functions.
What is true across the board is that over the past 18 months or so the combination of a flat yield curve, sub-par performance from the hedge fund universe as a whole and excess balance sheet across the street has accelerated pricing compression. While this has led the hedge fund financing function to become somewhat commoditised, there are, however, services that prime brokers can provide to help funds grow in other ways, including business consulting and capital introduction, both tailored to the specific needs of each client.
In both cases, this involves not simply inviting clients to events, but establishing a relationship with them to help both parties understand the context in which they are operating. Wells Fargo, for example, provides its hedge fund clients with peer group benchmarking, covering fees, performance and a number of operational criteria. Such benchmarking allows managers to see how funds to which they may be closely aligned in strategy and size compare across a variety of dimensions. The information thus gleaned can help fund managers refine how they bring their story to the market, while positioning their firms for growth from an organisational perspective.
Similarly, while producing white papers and articles on the state of the market is an important source of information for clients, their application to individual clients will require a bilateral approach. The ultra-large alternative asset managers, by contrast, tend not to rely on prime brokerage ancillary services, many of which are available to them in-house. For these clients, the priorities remain balance sheet, processing, reporting, and stability of liquidity.
It is not uncommon, particularly amongst the mid-tier client base, for firms to maintain a number of PB relationships for different purposes. A multi-billion-dollar fund, for example, may utilise multiple prime brokers, collectively covering a range of geographic, financing, risk diversification and investment needs, with each chosen for its expertise across these requirements. Even for a smaller fund, it is not uncommon to maintain different PB relationships for different purposes, including: institutional reputation; balance sheet; research; access to capital markets; and ancillary services. The fund will then, in turn, segment the relationships according to the perceived strengths of each provider.
Even within each function, two providers may be engaged in different ways. From a capital introduction perspective, for example, Wells Fargo is known to have a particular strength amongst family offices, endowments and foundations across the US. A client looking to attract such investors, as well as international allocators, may look for more than one provider.
Given this breadth of services available across the evolving prime brokerage landscape, funds should look to become more sophisticated in their evaluation of counterparties, as it would be a mistake to assume that competition is equal across the spectrum of services available to a diverse range of clients.