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Tapping into the hedge fund renaissance

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As hedge fund assets rise and performance rebounds, prime brokers can be a critical part of the industry’s growth.

The hedge fund industry is on the up. Following several years of patchy manager performances, a number of high-profile closures, and sustained investor reluctance to continue coughing up hefty fees 

in exchange for often-lukewarm returns, the sector is enjoying something of a renaissance. In 2021 hedge funds generated their third biggest annual gain since the Global Financial Crisis, while global industry 

assets under management swelled to record volumes last year – in the neighbourhood of more than USD4 trillion in total. At the same time, investors are said to be once again looking at how hedge funds can provide diversifying 

returns in portfolios. A study of more than 2000 hedge funds by Barclays last year suggested hedge funds now offer a “compelling alternative” to fixed income allocations within a traditional 60/40 portfolio, and could be key to 

strengthening returns amid a shifting market paradigm. “From the end of the financial crisis to the end of 2018, as market averages marched upward, it was very hard for alternative investment managers to stand out. The 

overriding theme was that they were underperforming while charging outsized fees. Then December 2018 happened, and they realised that hedge fund managers could still serve their purpose,” explains Jack Seibald, managing director and global co-head 

of prime brokerage and outsourced trading at Cowen. “This was an ‘ah-ha’ moment for allocators. And while it was short-lived, the onset of the pandemic brought back that ‘ah-ha’ moment, where you saw many hedge fund managers do 

very well in what they’re supposed to be doing, which is navigating very volatile markets and making idiosyncratic investment decisions in those environments.” Seibald adds: “The current environment lends itself to that expertise and I think the interest level in 

alternatives will remain elevated relative to the mid-2010s.” 

Momentum 

Against that backdrop, prime brokers appear well-placed to ride the current upward momentum in the hedge fund space. The past decade may have seen PBs’ top-line revenues squeezed thanks to lower market volatility, falling trading volumes across 

securities and sustained central bank intervention in global markets, while the Archegos and GameStop sagas have thrown up new challenges. But stronger performance, increased assets and newer markets nonetheless proffer a range of lucrative business opportunities for prime brokerage units 

further down the line. “The prime brokerage business is more important today than it’s ever been,” says Joel Press, founding member of hedge fund consultancy firm Press Management in New York, and former senior partner and head of the global hedge fund practice at Ernst & Young. 

“Prime brokerage is going to be a critical part of the growth of the industry – look at trading volumes, look at the number of new instruments that are coming to play. It’s also larger than it’s ever been, because hedge fund assets are somewhere in the 

neighbourhood of over USD4 trillion.” Observing the broader market landscape, Michael Webb, global head of prime equities at Barclays in New York, believes that consolidation will define much of the future growth trends in both hedge fund managers 

and the prime brokers that serve them in the coming years. “One of the big overriding themes is that this is an industry that’s more at maturity than it is an industry that’s seeing explosive growth as it did in the ‘90s and into the 2000s,” Webb tells 

Hedgeweek, noting that much of the growth in hedge fund AUM in recent years has been fueled predominantly by performance rather than additional capital inflows from investors.

“When you look at this industry, growth comes from scale and efficiency. So with the big getting bigger, which we’re seeing in the hedge fund industry, there’s going to be a corollary to the prime industry.” 

Stephane Marchand, head of international prime finance and clearing sales at JPMorgan in London, says: “The large global hedge funds are becoming more complex, more multi-product, more quantitative, more sophisticated. 

So prime brokers need to have almost a supermarket-like offering of all products. 

As soon as you take one product out, or are weaker in a certain area, it’s going to be difficult for a prime to move into the top tier.” Turning to the opportunities and challenges confronting prime brokers specifically, Webb says PBs must be able to service a client base that is “big, sophisticated, technologically-driven, active in every product, in every market, and continuing to grow and expand their footprint.” 

As a result, Webb believes the USD10 billion of losses resulting from the Archegos collapse demonstrated the difficulty that sub-scale, third-tier prime brokers face today. 

“Some will pack it in, but you’re also going to see others who are committed who will double and triple down in the business,” Webb says. 

With consolidation proving an enduring trend within the hedge fund industry over the last few years, prime brokerage participants concede that larger funds will continue to dictate terms in the coming years, with most PBs acknowledging that pricing power is still tipped in favour of the larger managers, with most brokerage shops remaining price-takers. 

Robust 

“In order to service these big hedge funds, you cannot be a niche player who’s only in one market, or in one product. You have to be full service because the client you’re dealing with needs full service and they’re looking at their wallet holistically. So that means that within the PB space, the big will get bigger,” Webb adds. 

“The client of the future is large and sophisticated, much more global. It’s cross-asset, it’s highly quantitative – they look more like sophisticated asset managers than hedge funds of the past. 

“Our business model at Barclays is to continue to be the only truly integrated prime on the Street. That integration is between fixed income financing, equity financing, US, Europe and Asia execution, financing and clearing. So all of the services that a hedge fund would need – the client base is going to demand that you are integrated across all products and services because that’s where they’re going. 

“If you’re integrated across execution and financing, the quants like you. If you’re integrated across fixed income and equities, the multi strategies like you. If you’re integrated across your equity and cash business and your prime business, the long/short managers like you. 

“The biggest clients in the world want to call up their prime broker and have a conversation because they need to finance, say, US 

government securities because they have got an RV strategy, they also need to finance JGBs, and their credit, and finance their long/short equity as well as their converts. 

They may also have a little bit of crypto. 

“They want to think about you, as a financing provider, as one holistic provider of all that. They don’t want to have 27 independent conversations on every asset class in every region.” 

Underlining the importance of controlled growth, Ashley Wilson, global head of prime services at BNP Paribas in London, believes there is “huge upside” potential for prime brokerage businesses such as his, as the hedge fund sector continues to evolve. 

“My focus is to make sure that each time we keep growing, we are very analytical about how the platform is performing and that it can handle this significant growth and the new business that we’re seeing coming in every day. 

“BNP has got the technology, it’s got the balance sheet, we tick that non-US box that many clients look for, and it’s got the management commitment to growing this business with serious investment,” he says, pointing to the firm’s acquisitions of French equity and research unit Exane and the Deutsche Bank platform. 

“But I need to be sure that the platform is working well, that it’s stable and scalable such that we don’t onboard too much too quickly.” Alexandra Krystal, managing director, head of prime services sales and capital introductions, CIBC Capital Markets, meanwhile points to the burgeoning opportunity set in asset-raising in Canada. 

“We create situational awareness among the Canadian investors and global hedge fund managers are reaching out to us to amplify their message in this market,” she explains. “If hedge funds want to grow assets in Canada across the family office, endowment, foundation, and pension fund space, CIBC Prime Brokerage has the unparalleled depth and breadth across this investor community.” 

Observing the evolving market dynamics of rising inflation, soaring commodity price rises and central banks retreating from asset purchasing programmes, Eamon McCooey, head of prime services at Wells Fargo, believes rising volatility and market uncertainty offers a “great opportunity” for hedge funds to differentiate themselves from long-only products within investment portfolios going forward. 

“I think ‘22 will be a good opportunity to see significant inflows, separate from performance, into hedge funds, given market dynamics. 

“Obviously if the hedge fund industry is performing well and raising assets, that’s more assets that prime brokers are financing. It’s very highly-correlated – a robust hedge fund industry bodes well for the prime brokerage industry.”


Read the full Charting New Territory: The future of hedge fund prime brokerage Insight Report here.

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