May 2, 2006/New York, NY - A research paper released today by Paladyne Systems LLC predicts that the need for multi-prime brokers is no longer going to be only a luxury for the larger fund managers but rather, with the increased industry and investor demands, will mean all hedge funds managers will, and are, moving aggressively towards having at least two or three or more prime brokers to service their needs.
Most managers avoid adding prime brokers until they reach a certain level of assets under management because they consider the technical structural challenges too complicated, the report found. But, as in most other industries, recent technological breakthroughs are pushing the hedge fund industry forward in ways that put the back, middle and front offices of a smaller fund on par with those of firms many times its size. More importantly, a move toward multi-prime brokerage relationships also allows manager's greater leverage to pressure for better rates from their brokers.
In fact, "open architecture" technology is enabling smaller hedge funds to suddenly have access to service that is actually superior to that which they had previously received from dominant primes, which hold more than 60% market share -- yet provide no technology to support multiple primes. In fact, competition between primes actually works against their interests, since these firms benefit from current brokerage inefficiencies.
Several major industry themes are highlighted in the paper:
The requirement of multi-prime brokers is no longer going to be only a luxury for the larger fund managers but rather, with the increased industry and investor demands, will mean all hedge funds managers will, and are, moving aggressively towards having at least two or three or more prime brokers to service their needs.
As hedge funds have grown to attract more institutional investors, managers are requiring more transparency into prime brokerage fees to better respond to sophisticated investors demands. In many cases, this has increased the need for second and third prime brokers to better manage such fees.
Specialized prime brokers may be ideal for small hedge funds. But manager's who are looking to effectively compete, and grow to institutionalize their business, quickly expand their interest into diverse strategies, across global markets and instruments. As for the primes, they are aggressively expanding the breadth of their services to retain and attract clients.
Typically, mid-size fund managers running between $100 million and $1 billion in capital (approximately 35% of all hedge funds, with 65% of the total AUM) are most likely to go through significant operational changes as they continue to grow their business.
While a price point can't be attached to adding a second or third prime broker there are added expenses in the form of people, processes, and systems. Prime brokers typically do not help managers with any of these challenges. Additionally, fund administrators do not usually have appropriate tools to facilitate these issues.
A mid-size hedge fund (say $500 million AUM) wishing to add a second prime broker needs to transition its operations from relying on a single prime addressing all their technology demands, to building their own infrastructure (technology products, necessary support staff and appropriate management processes), or outsource their technology management.