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Prime brokerage – A theme of disruption to fund clients

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By Jorge Hendrickson & Mark McGoldrick
Managing directors, co-heads of prime brokerage, JonesTrading

Should hedge funds adapt their business to cater to their prime broker? Are prime brokers doing enough to adapt to the fund industry’s evolving needs? Like anything else, there is a balance and healthy middle ground. Some primes are contributing to the pain for funds, while others are entering the market with a fresh approach. 

This article will list some real and recent examples of how the evolving dynamics within the prime brokerage industry have caused disruption for fund managers, and some key considerations that are often ignored.

The shifting tides in prime brokerage (PB) have caused a significant change in both the cost and service offered over the past few years with many funds getting caught in the churn.  As a result, fund managers have been forced to make operational and counterparty decisions that may not actually be ideal for their portfolio, workflows, cost structure and most importantly – their investors.

The shift in the prime brokerage space is a residual effect of some formerly major players leaving the field.  Thus, forcing larger primes to evaluate their client base strictly through the lens of revenue and operational utilization in an attempt fill that void and capture market share.  The result of that evaluation, oftentimes, is an increase in revenue targets, material change in service and in some cases fund managers being asked to leave the platform altogether. The PB’s reasoning certainly makes sense from their perspective, and within the context of its overall business model and marketplace. However, this dynamic has brought difficult choices for fund managers.

When the manager first started the process of selecting a PB, they had ostensibly found one who can properly service their portfolio at an agreeable rate. However, after a period of time on the platform, the fund manager’s perception is that they are held hostage to their initial prime brokerage choice. With little notice, a PB can implement new fees, knowing that the fund would rather pay than search for a new prime broker. Usually this comes at the most inopportune time, when the fund manager finds themselves at an important inflection point of their growth cycle.  A time when they should be solely focused on performance, not changing service providers.

Prime Brokers are businesses too and they do need to monetize all clients, but abrupt material changes in deal-terms can have measurable impact on fund performance and the service relationship. These fee changes also overlook the underlying investors who ultimately bear the brunt of this increased cost through performance drag.  Partnering with a PB that is transparent on fees, revenue expectations and is willing to take a long-term view of your business is vital to a fund manager’s success.

Another consideration for fund managers evaluating their prime brokerage partnership pertains to counterparty risk.  Managers find themselves in a bit of a quandary; accept higher fees which will affect future revenue expectations or go with a low-cost solution and make sacrifices.  For those choosing not to pay higher fees and change PBs, counterparty risk is often overlooked.  Again, there is a balanced and healthy middle ground.

The topic of counterparty risk is once again of key importance in our industry, and fund managers have fewer choices these days. As an introducing prime to three high quality custodians, JonesPrime stands by the concept that funds should not have to sacrifice quality in this category. We take a thoughtful approach with clients to find the right prime brokerage infrastructure for a particular fund or strategy – which may also include a multi-prime solution if necessary.

If done right and in partnership with your PB, having an efficient and scalable architecture is also a key component to a successful investment management business. With the myriad of industry technology solutions available today (EMS, OMS, data, risk tools, PMS, portfolio reporting), it is imperative that a prime broker take an “open architecture” view to their service offering. Fund managers are often forced to make drastic changes to the workflow and technology set-up they originally envisioned just to cater to the PB’s offering and requirements.

Engagements like these make managers feel like they are merely a cog in a prime brokerage machine and not at all like the business partnership for which they planned.  Choosing a PB who demonstrates a willingness to be collaborative with the fund’s set-up allows investment managers to be nimble and scalable. Both key attributes allow emerging managers to differentiate themselves from their competitors and attract a more diverse investor base.

A good example of this can be found in the continued growth of separately managed accounts.  Many institutional investors seek access to investment strategies via managed accounts, typically for control and transparency purposes.  For fund managers with the right strategy, it is an attractive way to boost firm AUM – a key metric for continued asset raising. However, fund managers willing to entertain this source of capital must consider the operational impact an SMA may have on their day to day. Aligning yourself with a prime broker whose model can facilitate the entire workflow associated with your investment management business and asset-raising needs is imperative.

While leveraging technology can automate workflows, data processing and reporting, in times of volatility, funds will have urgent needs that can only be met with a high touch approach to client service. Today, because of a reliance on technology, client service matters more now than ever. This is essential for start-up and emerging managers especially given the continued fee compression they are experiencing from the investor side.  By being forced to do more with less, engaging a prime broker with a higher level of customer service and support is critical. With the right service model and technology set-up emerging managers can save on cost and allocate more of their precious resources towards generating alpha.

A partnership approach to support, collaborative problem solving, counterparty risk and client service will separate a prime service offering from other low touch or boutique self-clearing peers. JonesPrime is focused on solving these pain points for clients and recognize that funds ultimately need a long-term partner who will approach the relationship with an open dialogue, competitive pricing, asset safety and an eye towards lasting success for the fund manager.

Jorge Hendrickson, a managing director and co-head of prime services, JonesTrading – Previously, Jorge  was chief revenue officer at Opus Fund Services. Prior to that, he worked in prime brokerage sales and capital introductions at Concept Capital Markets (now Cowen Prime Services). He also worked at Bay Head Capital with a focus on new launches. He held a variety of operational, trading and investor relations roles at Intrepid Capital Management and Bridgewater Associates. . He is experienced in advising fund managers on launching, operating, and scaling their investment management businesses. In 2021, Business Insider named him one of the “29 people to know when launching a fund.” He has worked with numerous funds over the years across Hedge, Private Equity, Venture Capital, Real Estate and Private Debt.

Mark McGoldrick, managing director, co-head of prime brokerage, JonesTrading – Utilizing his knowledge and experience, Mark acts as consultant to new and emerging hedge funds by guiding them through the arduous process of launching and growing an investment management business. Mark has extensive trading and prime brokerage experience dealing in all facets of the alternative space from fund formation, managed accounts, execution and risk management to marketing and capital introductions. Prior to Jones Trading, Mark was a director of prime brokerage and outsourced trading at Cowen. Before Cowen he was a founding member and head of marketing and business development of boutique prime broker Alaris Trading Partners, LLC. After five years in operation, Alaris was acquired by Concept Capital Markets, LLC in August of 2011 where he helped lead the transition to Concept’s platform. Concept was then acquired by Cowen Prime Services, LLC in September of 2015. Prior to founding Alaris he was employed by UBS Securities, LLC as associate director in the prime brokerage division working with hedge funds in a sales, relationship, and capital introductions capacity. Mark started his career in finance with State Street in the portfolio accounting division covering the Paine Webber funds.

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