In our most recent insight on prime broking, we talked about how a higher interest rate environment could affect decisions about the kind of prime brokers a fund might consider, including the question of what level of service is on offer. In our latest post, we delve deeper into the importance of high-touch service. At a time when the prime brokerage industry is undergoing big shifts, it’s a question that matters more than ever.
When hedge funds are sizing up potential prime brokers to see which firms might best meet their needs, they have a lot of boxes to tick. So, it’s understandable that the subject of banks’ balance sheet trends is probably not the first thing on their minds. But there’s a good reason why this topic looms large and is worth dwelling on.
Put simply, banks – even the bulge bracket firms – do not have endless balance sheets. If anything, the sizes of balance sheets are starting to taper off after years of growth, according to data from central banks in the United States and Europe. Central banks themselves have been unwinding their quantitative easing strategies and looking to reduce their own balance sheets, which has knock-on effects.
For new and emerging funds in particular, all of this has implications. As the number of large providers has contracted, the remaining bulge bracket firms have ended up taking on lots of recently displaced clients. But they cannot simply expand their balance sheets ad infinitum in order to absorb these new clients while still retaining all of their existing ones.
Instead, the biggest prime brokerage providers end up having to become more selective. The cold reality is, they need to make the call as to which funds will move the needle when it comes to their own business. It inevitably leads to dislocation and off-boarding.
The dislocation dilemma
For funds that have themselves been off-boarded, their first priority is to think which providers are best placed to serve their needs. And for new funds that are just getting started, they need to think about whether they want to risk the chance of dislocation further down the road by focusing purely on the largest providers. We have been hearing from firms in each of these categories.
What both camps will have in common is that they would benefit from focusing on providers that have a high-touch service approach. It may come down to a fund’s size. Or it may be due to what a fund hopes to achieve. Or it may be because a fund is new to the market and likely to be encountering unfamiliar situations. In fact, this last consideration is increasingly the case in today’s markets, as risks accumulate from multiple directions. Unusual or unfamiliar market scenarios may be the result of macroeconomic shifts, regulatory changes, geopolitical factors, or a host of “unknown unknows”. Whatever the cause, having a prime broker in your corner that can help you deal with the unfamiliar is a big plus.
Getting a handle on high-touch
What does “high-touch” service look like? From a TD Cowen perspective, it’s a range of things.
First of all, high-touch service means we’ll work around the client, not the other way around. For instance, we don’t mind tailoring a system or process to fit the client’s requirements. If it’s new or different functionality that is needed, we’ll aim to figure out a way.
A big reason we can take this approach stems from in-built flexibility. Many prime brokers may have evolved their offerings over the years, but a client-centric service approach requires being flexible in incorporating client needs immediately, not over time
Another important element concerns how quickly issues can be escalated. Despite TD Cowen’s size, breadth and institutional focus, our structure is very flat and easy to navigate. This means that if a client does have any issues, they are not far away from senior management. Busy hedge fund managers have enough to worry about without having to deal with slow, bureaucratic processes from their prime brokers. They need to know they will be listened to and responded to, quickly.
Finally, high-touch means supporting the whole business. A prime broker needs to have the experience and resources to offer a full suite of services, from raising capital to trading and execution to operational support to consulting.
To cite one example, one of TD Cowen’s differentiators is the fact that we can refer funds that have trading needs over to our outsourced trading desk team. For funds that don’t want to trade electronically from their desktops, that option is there and we’ll work with them to address their particular requirements. Or, they may have specific needs for reconciliation and operational support. For instance, a fund may have an SMA (separately managed account) located elsewhere but also have assets with us. High-touch service means providing solutions that address the client’s entire business, not just the parts of the business that directly touch us.
A return to normalcy?
The prime brokerage industry has been in a state of flux for the past couple of years, which makes the question of who to pick and what factors to weigh all the more complicated.
How long the dislocation trend will continue, no one can say for certain. But we do know that more funds are launching, offering signs of a return to normalcy for a hard-hit buy-side community. Quarterly data for fund launches at one point in 2022 reached their lowest level since the 2008 financial crisis, but Q4 showed a 35% jump to 96 launches. It means more funds are going to need to navigate a tricky prime brokerage landscape. We think focusing on high-touch service could be one of the keys to their success.
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