As the world of alternative investment grows, service providers to hedge funds need to adapt and restructure their offerings to sustain growth and keep clients happy.
As the world of alternative investment grows, service providers to hedge funds need to adapt and restructure their offerings to sustain growth and keep clients happy. Administrators and prime brokers face tough technological and infrastructural challenges as they compete to provide services to the dynamic breed of hedge funds.
Prime brokers and custodians are in essentially different businesses. The primes will make their money from transactional activity and financing; the custodians are primarily outsource service providers of safekeeping, cash management and administrative services. Now the line between these two is becoming blurred. The apparent convergence between the two worlds occurs because of the expansion of additional value-added products by both groups. However the custody and trust banks generally do not have the risk appetite of the broker dealers and are fundamentally averse to the leveraged financing that is the specialty of the prime brokers.
And everyone seems to be getting into the act. The credit crunch has given a strong push to financing counterparties that are owned by commercial banks. This is at the expense of pure broker/dealer firms, for reasons of balance sheet strength. Examples of the winners from this first phase effect include Citi, UBS, Credit Suisse and Barclays, amongst others. A second phase of the credit crunch occurred when Bear Stearns nearly collapsed and was taken over by JPMorgan Chase. This phase is characterised by a move of unencumbered assets, both cash and securities, away from prime brokers of all types and into pure custody accounts at banks such as The Bank of New York Mellon. This multi-billion dollar ‘reverse enquiry’ activity, whereby assets are moving at the insistence of the hedge funds and not at the suggestion of the custodians, appears to be designed to ensure that these assets are free from the ‘de facto’ restraints of a prime brokerage agreement and ‘de jure’ solely under the direction and control of the investment manager.
The fact is that everyone wants to establish long term relationships with their clients, and providing additional ‘sticky’ services is one of the ways that firms will try to do this. The Bank of New York Mellon offers a range of a la carte services, under the marketing term ‘banking plus admin,’ which collectively deliver to alternative fund managers a relationship closer to a marriage than a date. Managers want stable relationships with providers who are investing in their businesses through the provision of class leading services.
While there can never be a truly one stop shop model for hedge funds, as the range and nature of their requirements are so varied and broad, what does work is the provision of multiple services by a single organisation, essentially a bespoke mix of solutions to meet the managers’ needs for their funds. Infrastructure must be connected and the management of the service provider has to be aligned closely with the partners of the fund.
Meanwhile, scale is becoming an increasingly important consideration. We have just completed a multi-million dollar investment in transfer agency services to meet the particular needs of one of our biggest European clients. We intend to deliver these services to other interested and sophisticated hedge funds, but we made the investment commitment initially based on just one manager’s needs. This option is only really available to a few of the leading asset servicing organisations globally, and The Bank of New York Mellon is well placed to do this with over USD 200 billion in assets under administration in alternatives alone and a total of over USD 22 trillion under custody and administration across all assets types.
With the ongoing uncertainty, service providers need to be smart to tackle the challenges of increasingly complex security types and an ever-changing regulatory environment. Major international asset servicing organisations like The Bank of New York Mellon are primed to lead the way.
