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Enhancing transparency

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Poor hedge fund performance over the past 18 months means that managers face continued fee pressure from investors. As a result, smaller and emerging hedge funds are becoming increasingly attracted to non-conventional prime brokers that are able to offer automated solutions for risk management, account management, trade execution and pricing. 

Leading the pack is Interactive Brokers, which has been built on three pillars: low cost, breadth of product (globally) and best-of-breed technology and trading tools. 

"These things are becoming much more important as the hedge fund industry becomes more competitive," says Steve Sanders (pictured), EVP, Marketing and Product Development. "What is of particular importance is transparency. A good example of this is our stock lending program. 

"Traditionally, if you wanted to find out what the borrow rate was for a stock you would call your broker and they'd give you a rate. At Interactive Brokers, we provide the tools for the client to find out for themselves. Clients can review what the latest borrow rates are in real time and decide whether or not to do a trade."

Interactive Brokers can be viewed as a technology company that operates in the PB marketplace. At a time when bank-owned primes are overhauling their legacy IT systems to bring them into the 21st Century, the ability to remain nimble and technologically lean is working in the favour of non-banking primes like Interactive Brokers. 

Another facet of transparency is Interactive Brokers' IB SmartRouting technology, essentially an algorithm that ensures the best price execution is achieved.

"We would like brokers to get more transparent and report their prices," states Sanders. "We use a third party called Transaction Auditing Group (TAG), which goes out and compares us against the best bid and offer for our executions. Our US stock and options price executions continued to be significantly better than the industry during the first half of 2016; a USD0.43 price improvement compared to USD0.34 for the industry."

A third element of transparency is that commission rates can be viewed on the IB platform. Clients know exactly what the rate is. The higher their trade volume the lower the rates. 

"I think the future is not to have middlemen but to provide direct access to hedge funds on lending and commission rates. Millennial investors are a lot more comfortable with technology and if possible would rather do it that way; they expect data on demand today. 

"Another example of transparency is our Stock Yield Enhancement Program. If a client is fully paid with a stock the broker cannot lend out that stock. With us, the client signs an agreement that gives us permission to lend out the stock, after which we split the fee with the client. 

"This is normally only done for the largest clients at other prime brokers but we make the program available to everybody. People are beginning to see that this level of transparency is the way of the future," says Sanders. 

He confirms that over the last 12 months Interactive Brokers has been attracting more small and mid-sized hedge fund managers because the larger primes are no longer supporting them. 

"We offer great technology, we are a cost-efficient solution and for anyone starting up a hedge fund we are a good option. Even if other primes were to take them, in my mind we still hold an advantage," concludes Sanders.

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