The Why of Adding a Prime Broker

Dennis ChenFu


The Why of Adding a Prime Broker

I’ve never kept my personal accounts at a single bank. I like one bank because it pays a high interest rate. Another delivers an exceptional online user experience. And yet another is a neighborhood bank with relationship retail bankers who know me and my family. My preference for diversifying where I do my personal banking is not unlike the conversations I have with hedge funds that are contemplating using more than one prime broker. That is: are you at the place where adding a prime broker will help increase the efficiency of your firm?

Having multiple prime brokers is not a one-size-fits-all strategy. Depending on the size, strategy, and financing needs of your fund, working with a single prime may suit those needs. However, some funds are at the point in their lifecycle where they may benefit from working with more than one prime broker.

What makes a complementary broker?

Not all prime brokers are alike, and there are myriad services available to provide operational efficiencies to your fund. Some prime brokers may offer outsourced trading or platform distribution. There are prime brokers that deliver rate transparency, and some offer market expertise. And let’s not forget about capital introductions!

In fact, you may even find a prime who can offer several of these capabilities. The point is that hedge funds can gain an edge by having the right mix of prime broker relationships, so take a look at the products and services your current prime offers to see if adding a prime broker can help fill in some gaps.

There is one capability in particular that you should consider when adding a prime: securities lending. Every prime broker has a unique pool of available securities, so lending capabilities will vary from prime to prime. For example, primes connected to a clearing broker have vast institutional and retail client bases and can offer a differentiated supply of lendable securities – especially hard-to-borrows. Keep in mind that funds who do business with only one prime miss out on the opportunity to compare rates across their prime broker wallet. Moreover, one prime broker’s stock loan inventory may have a more natural match to the short book of a hedge fund.

Diversifying a portfolio

Fluctuations in the financial markets can expose hedge funds to a number of risks. Funds with only one prime broker may be able to combat some of the challenges posed by market turmoil. They are limited, however, by the risk exposure to that single prime. Understanding the safety and soundness of counterparty relationships is paramount, and adding the right prime broker may help you reduce and mitigate counterparty exposure. Moreover, funds working with a prime that is affiliated with a custodian bank can also benefit from a suite of products such as prime custody or cash management, which complements products offered by bulge-bracket banks.

For institutional investors who are always looking to diversify their assets and reduce risk while maximizing returns, the right prime broker can add stability to a hedge fund’s operations. This is critical, as having multiple primes can broaden your fund’s contingency planning options should the industry face significant market turmoil.

The value of the right relationships

The world of alternative investments is characterized by hedge fund managers who see opportunities where no one else does. It’s filled with financiers who look at the capital markets with a fairly rare combination of quantitative analytics and creativity. That’s why the hedge fund is still very much a business built on relationships. I’ve heard from many managers over the years that they’re just not ready to add a second or third broker to their operating model. That perception changes when they start meeting my team, attending the many events and networking opportunities we host, and coming away from each event with a better understanding of our value, how we can help reduce risk, and help with managing their liquidity.

Bulge-bracket brokerages will always have an important role to play in the life of a hedge fund. Let’s not forget, however, that funds work most effectively when they have a diverse roster of prime brokers with different risk profiles and complementary suites of services. The ultimate goal of a hedge fund is to deliver outperformance versus a benchmark – and it can’t do so without working with a prime broker that helps to reduce risk while helping the fund deal with the ever-increasing complexity of today’s investing landscape. For more insights on the trends that have changed the dynamics of the hedge fund/prime broker relationship, please read a recent article authored by Mark Aldoroty, head of Pershing’s Prime Services and Collateral Funding & Trading groups.

Dennis ChenFu

Dennis ChenFu

Dennis ChenFu is a Vice President for the Prime Services division of BNY Mellon | Pershing, based in Los Angeles. He is responsible for new business development on the West Coast as well as managing existing relationships with alternative asset managers. Dennis also helps clients and prospects with financing, liquidity and operational efficiencies.