Prime broking in a new era: Helping funds adjust to turbulent times

In a new blog series on prime broking, TD Cowen looks at factors to consider for selecting the right provider after the past year’s surge in interest rates.

Interest rates in major economies have risen dramatically in the past year, in a number of cases reaching levels not seen since before the 2008 financial crisis. As a result, portfolio managers face a radically different market dynamic, one where the assumptions that were built into a range of investment approaches no longer automatically apply.

At the same time, many fund managers, until last year, had little experience with this kind of environment. Before interest rates started to climb, equities had enjoyed a nearly two-year bull run (just check out the S&P 500 from March 2020 to January 2022, which is more or less a straight line). But the past year and a half have been much choppier, as the risk-on trade has ceased to be the default position.

How can a prime broker help during such turbulent times? It’s worth considering a few factors when thinking about which prime brokers you want to have in your stable.

One of the main ways a prime broker can provide support is through consulting. At TD Cowen, we see a big part of our role as being there to explain situations that might be novel to some fund managers, particularly in the case of emerging funds. For instance, the upward shift we’ve seen in yield curves has created fresh incentives to do more than keep excess cash in money market accounts. But not every manager will know what opportunities there are, or what might be involved in seeking to tap into them. Also, not every prime broker has the bandwidth to engage in such in-depth conversations with all of their clients.

We see two major questions that managers – whether they are large or small funds – should be asking as they consider adding a new prime broker. First, what kind of service does the prime broker provide? Second, does the prime broker have the right suite of services to help a firm take advantage of opportunities as they arise?

Bulge bracket providers can obviously perform well on both counts, but they may face constraints in terms of high-touch service provision due to the sheer number of clients they have to support. In other words, they may not always be able to provide the level of TLC that some fund managers would want. At the same time, smaller prime brokers may perform well on the first question but not so well on the second. The sweet spot is when a prime broker fits the bill with regards to both questions. We think of ourselves as one of the prime brokers that sits in that sweet spot, in that TD Cowen makes it a priority to deliver high-touch service to each and every client, while offering a full suite of institutional-grade services, including our award-winning trading desk capabilities.

In this post, we’ll look briefly at both of those questions and tease out some of the key issues.

The right service ethos

You can expect all prime brokers to talk positively about their focus on customer service. But the service a fund receives can vary, depending on the size, personnel, culture and business model of the provider. For instance, large bulge bracket providers may have to reserve more of the personalised service for their biggest clients. For a start, many of them simply don’t have the bandwidth to handle detailed, time-consuming questions from all of their clients. To put the numbers into perspective, when Credit Suisse exited the prime brokerage market, it had about 1,800 clients. At the other end of the spectrum, some smaller prime brokers may not necessarily have the experience or expertise to deal with every request and scenario.

Why does this matter more now than before the past year’s upheaval? Because so many managers, particularly those who have been focused on equities for the past decade, have incentives to look more seriously at other asset classes. They would benefit from having a prime broker that could answer their questions and facilitate new types of trades. Most of the larger prime brokers are unlikely to be prepared to spend the time required to discuss with all of their clients, for example, the pros and cons of something as simple as switching into very short term Treasuries from cash or money market funds in the current environment, how that would impact their workflows and how it may benefit their fund. These kinds of questions may be obvious for funds that are familiar with interest rate products and strategies, but there are plenty out there that don’t have that experience. Having the capabilities to then facilitate the transaction for the client in an efficient and cost-effective manner completes the service.

Since most funds had grossed down exposures since the latter part of last year, many had begun to carry meaningful credit balances more consistently. This provided us the opportunity to engage with our clients, alert them to the better rate spreads, and add value with our capabilities and service oriented approach. TD Cowen was ranked among the top five prime brokers in the latest Global Custodian survey in consulting. For new funds with less-experienced managers, this level of service can help them explore unfamiliar terrain quickly and with minimum fuss. We’ll be writing more about the benefits of “high-touch” service in prime broking later in this series.

A holistic approach

Outside of the bulge bracket firms, there are not that many providers that can draw on the knowledge, experience and trading capabilities of a large team of veteran traders, as TD Cowen can. In a recent blog on TD Cowen’s outsourced trading offering, we went into detail on the ways that funds can take advantage of our outsourced trading solutions and why that makes sense in this macroeconomic climate.

As the blog pointed out, a key factor is the level of expertise a firm has. TD Cowen has been expanding its outsourced trading team in recent years, so it has the know-how to help funds, whatever their needs. This is an area where we have won multiple awards and are recognised as a world-leading provider. That means we are better able to help funds that need trading support.

Looking ahead

Last year was marked by a sudden jump in inflation, putting strong upward pressure on global interest rates. At the time of writing, the inflation situation appears to be calming in many developed economies, which in theory takes some of the pressure off. But no one has a crystal ball.

More to the point, there is a sense that the interest rate genie is out of the bottle. After short-term rates hovered close to zero in the United States for many, many years, yield curves around the world have now shifted. That creates both new possibilities and new pitfalls for funds. Managers looking to exploit the former and avoid the latter can benefit from a prime broker that knows its way around the credit markets.

Interested to learn more about TD Cowen’s prime brokerage offering? Go to: https://www.TD Cowen.com/capabilities/markets/prime-brokerage/