"There is a clear message coming out of the marketplace that we are responding to. The smaller and medium-sized managers are being squeezed out of the tier one primes and have nowhere to go," states Jerry Lees, Chairman of Linear Investments. "There is a momentum in the marketplace forcing change. The impact of Basel III on banks' balance sheets means they cannot afford the infrastructure costs to continue supporting smaller hedge funds and this has created a gap."
This means small to mid-sized hedge funds are finding it harder to establish a strong prime brokerage relationship.
This is good news for specialist or 'boutique' prime brokerage providers like Linear Investments. Linear does not have the large overheads of a bank or the associated infrastructure costs that come with running a global bank institution.
"What is unique about Linear is that we've put together a comprehensive platform. The issue that a small hedge fund has is this: if they are distracted by the process of having to set up all their IT structures, their operational structures, handle all the regulatory issues, it effectively leads to a performance lull. They become distracted by all the other requirements of running a hedge fund that stop them focusing on their key business: managing the portfolio and generating returns," says Lees.
A star trader at an existing hedge fund or bank is used to operating in an environment where everything is done for them. Linear is basically offering that same environment, giving new managers the chance to build a successful hedge fund business without myriad pressures.
"We give the manager the whole operational framework. They can walk in to our offices, take desk space, and start managing the strategy. We have all the technology, voice recording, and risk systems that meet regulatory standards. Once we set up the client everything is handled by our operating team. We also use an outsourced compliance firm to provide all the necessary compliance oversight," explains Lees.
Linear's clients get an array of services that go far beyond the typical prime brokerage relationship.
This specialist hands-on PB model is being well received among new managers and those rotating out of existing prime relationships where the manager wants a more inclusive, meaningful partnership.
Discussing the Linear model, Lees says that Linear has relationships with executing brokers in every asset class.
"Depending on what the client wants to trade, we have different PB accounts. Each client has a sub account and the global execution broker sees us as one big account. Our omnibus account is fully hedged back to the underlying broker. We never take risk exposure. We've also got Linear's capital base backing that omnibus account structure so it's a safe environment."
Linear uses five executing prime brokers including Nomura, R.J. O'Brien, ICBC and also has a custody and clearing arrangement with Societe Generale.
Also, as Linear has a global financing deal with its executing brokers, the fact that overall trade volume in the omnibus account is substantial means that it is able to pass on competitive commission and finance rates; something that emerging managers are only too grateful for.
"We have 105 hedge fund clients trading with us in different ways and we have another 60 clients at private banks doing execution only work. The big banks are not equipped to offer the same specialist model that we provide to the market," concludes Lees.