“Prime brokers, fund administrators and technology providers are converging on hedge fund managers. The three groups are eagerly adding ancillary services or launching new or enhanced solutions for the hedge fund community. All three are encroaching on each other’s traditional service or solution areas,” states an earlier Celent report, “A Cottage Industry Goes Mainstream: Hedge Fund Technology in the Spotlight.”
Traditionally, prime brokers’ core business has focused on trading, clearing and settlement, and custody facilities, as well as the more lucrative aspects of financing and securities lending. However, prime brokers are offering a growing list of additional services, notes Valentine, including portfolio systems, partnership accounting, portfolio risk analytics, margin and cross margin, and aggregated reporting. But, she adds, “Many of these additional services can be duplicated by fund administrators, technology providers and even outsourcing firms.”
Certainly, fund administrators are seeking to provide an evolving array of value-added services. Four or five years ago, all a third-party administrator did were month-end net asset values (NAV), while hedge fund managers looked to their prime brokers for portfolio reporting, risk-management systems, performance measurement and attribution systems, according to Stephen Hixon, chief operating officer for North America with BISYS Hedge Fund Services. “That is significantly changing,” he says. “What you need to do now is provide what we call daily P&L, where you are posting all the trades on a daily basis, reconciling positions and cash every day, and pricing securities every day.”
The driver, Hixon explains, has been the trend among managers to use more than one prime broker. Whereas prime brokers used to provide a lot of information, managers now are unable to get all the information they need from a single broker, so they are looking to their administrators instead, he relates.
“Hedge funds rely on four key service providers: TPAs, prime brokers, attorneys and accountants. Each delivers distinct services,” he relates. “While TPAs have expanded their offerings to include some services offered by prime brokers, they are generally operational in nature.”
Seth Weinstein, president of the newly launched Morgan Stanley Fund Services and a former senior member of the firm’s prime brokerage business, makes a similar point: “The two, while sharing many synergies, are stand-alone businesses,” he says. “In many ways, the TPA picks up where the prime broker leaves off,” he continues. “The market differentiation, from both sides, is in how well the respective services are integrated.”
One area in which prime brokers continue to predominate, though, is in the servicing of start-ups. If you are working with start-ups, the idea is to get to market quickly, according to Celent’s Valentine. The idea that a prime broker can offer a one-stop shop – office staff, administration, a room in a building, phones, a trading terminal – has been very attractive, she relates.
And other areas of prime broker service differentiation remain. “There is the balance sheet, the financing, the stock lending, the credit intermediation piece, which is still going to be the domain of the prime broker,
fund administration is central to the operation of a fund in terms of having responsibility for gathering all the fund’s data, reconciling positions and holdings, and reporting the fund’s NAV. Administrators are also in a better position to offer middle-office, risk and consolidated positions compared to brokers, he adds. “With so many hedge fund managers using multiple brokers and counterparties, only the administrator is in a position to see everything that is happening,” Schultz explains.
