Prime brokers rise to the challenge as funds seek stability and service

The prime brokerage sector has been through turbulent times but has reset with a renewed determination to help funds meet their goals.

The impact of several major players leaving the market has resulted in a shake up in the prime brokerage sector, with a number of prime brokers emerging stronger and having an even sharper focus on what their clients need in challenging circumstances.

Fund managers have also had to adapt, with many re-thinking their approach to prime broking; becoming more selective, working with multiple prime brokers to help manage and grow their business.

As we move into 2023, the global economic outlook is dominated by worries about inflation and rising interest rates as central banks battle to bring it down. Yet the market volatility expected to result could give rise to opportunities for certain strategies, suggesting good times ahead for some in the industry. Others may face redemptions as some investors pull in their horns.

For some prime brokers, the shake-out in the industry has left them standing on firmer ground and viewed by fund managers as a source of the stability they crave. One such firm is global investment bank Cowen, which has demonstrated a clear track record of solid performance and a consistent commitment to supporting their clients for many years, and is consistently ranked among the top 10 best prime brokers by Global Custodian.

Here are five themes to watch in the industry in the year ahead.

The allure of mid-tier prime brokers

Many fund managers may initially look to bulge-bracket banks for prime brokerage services. Their global reach and reputations make them highly attractive for fund managers, and this is not expected to change.

However, there is an argument that a prime broker’s size is less important than it was. The priority for a fund manager is to work with a prime broker that offers capabilities to match those required by the client, particularly if those match what the bulge-bracket banks offer combined with a very high level of service.

When you consider that some larger prime brokers can demand certain levels of revenue from the relationship, and might down-grade or even off-board a client who misses the target. Industry insiders say that funds are likely to get more time and attention, and conversely better service with a mid-tier prime broker.

With this in mind, it seems likely that more fund managers will explore the solutions offered by mid-sized prime brokers in the coming year.

Funds seek value by adding complementary prime brokers

One of the consequences of fund managers rethinking their approach is a trend towards partnering with several prime brokers, especially those offering the full spectrum of services.

This emerged in the dislocation that followed a family office default in 2021, with many fund managers looking for alternative providers at the same time as the larger institutions looked to acquire clients of their retrenching peers.

Fearful of further upheaval if other prime brokers leave the market, fund managers say they want stability, consistency and the full range of services they need to grow their businesses. This has led them to diversify their options by engaging non-bulge bracket firms, especially those with the right capabilities.

Irrespective of a prime broker’s size, adding a second or third prime broker brings many benefits. Fund managers gain access to different product offerings, allowing them to either complement those of its current partner or to fill gaps. With the right prime broker, they might also experience more attention and focus on their needs. A less tangible but important benefit is that with more prime brokers come more perspectives on the markets and more opportunities to access useful advice.

Outsourcing set to accelerate in 2023

An important part of many prime brokers’ offering is outsourced trading – just one of the many functions hedge funds are outsourcing in the search for efficiencies, access to expertise, and operational excellence. Once viewed with suspicion by institutional investors and larger hedge fund managers, outsourcing is now considered a wise move for fund managers, especially in a time of tight budgets, falling AUM and flattened fees.

In 2023, some funds are expected to outsource to rein in costs, while others, in the early stages of their development, will see it as an efficient way to access services that can help them grow.

Outsourced trading allows fund managers to access expertise they may not have in-house or to supplement their own traders. They can also extend their reach by trading in unfamiliar assets or geographies Other functions regularly outsourced include compliance, technology, back and middle office, risk management and HR.

Capital introduction to play a vital role in 2023

The risk of further redemptions in the coming year is likely to lead to increased demand for capital introduction.

Global investors pulled $26 billion from hedge funds in the third quarter of this year, shrinking total capital in the sector to $3.78 trillion, according to HFR data. This will put cap intro services in the spotlight, particularly among emerging hedge fund managers.

Some prime brokers specialize in bringing together these emerging managers and early stage investors, including family offices, fund of funds, endowments and foundations. The breadth of prime brokers’ access to potential investors is likely to be another criterion for managers looking to partner with a prime broker.

Leaders in this service will conduct a rigorous analysis of potential investors before introducing them to their investor clients to ensure their expectations are compatible.

Prime broker track records will face greater scrutiny

Expect fund managers to cast a close eye over their potential prime brokers’ track records in the year ahead.

They will be looking for a sound record of performance, longevity of experience in the business and commitment to their clients. They will also expect the full range of prime brokerage services. All of these attributes will have to match the size and ambition of the fund.

These days they might well ask if their prime brokers have experience of working through seismic shifts in the global economy.

Another important criterion will be the strength of the prime broker’s risk management. Given the recent steep losses experienced by some prime brokers, regulators have reviewed risk management measures at banks providing such services, warning them to invest in their risk management framework and control infrastructure.

What else fund managers look for depends on their specific needs. While a fund at an early stage of growth might look to a prime broker for capital introduction, a more seasoned firm might be more interested in outsourced trading or expertise in a different asset class.

Final thoughts – Don’t miss out

Prime brokerage is evolving. Veterans of the industry say the number of players may well shrink further, while the trend among funds to take on multiple prime brokers will accelerate. Fund managers need to choose carefully when selecting a prime broker.

Cowen offers bulge-bracket-matching capabilities and is renowned in the industry for its high-touch, “white glove” levels of customer service. With its global banking pedigree and expertise, it has the track record that forms a vital part of any decision to engage a prime broker.

Cowen’s commitment to satisfying clients over the long haul also included taking a proactive, client-focused approach to margin models in the turmoil in 2021. The firm has added clients in the displacement, taking a thoughtful approach to ensure the client’s needs align with Cowen’s capabilities

In the 2022 Global Custodian Prime Brokerage Survey, Cowen ranked in the top 10 prime brokers for the fifth straight year and was one of only six firms to have ranked every year for the past 11, and the only non-bulge bracket firm to do so. 

Cowen remains committed to prime brokerage, all the while preserving its entrepreneurial, client-focused and values-based culture.