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Prime Broker Considerations For Emerging Hedge Fund Managers

Launching and growing a hedge fund has never been more onerous. Emerging hedge fund managers face ever more intensive regulatory and investor scrutiny, but the practical side of launching and running a hedge fund successfully is often underestimated, from selecting a prime broker to making sure your NAV is accurate. AlphaWeek’s Greg Winterton spoke to Steve Bower of prime broker CGS-CIMB to learn more about some of the questions new hedge fund managers should be asking themselves when it comes to prime broker selection.

GW: Steve, it’s said that the primary driver of a hedge fund managers’ prime broker selection is based on the capital introduction part of the service. What do hedge funds need to be conscious of with regards to their expectations of cap intro?

SB: There are a number of factors that new or emerging managers will consider when selecting a Prime Broker and yes, capital introduction services are often a key driver in the selection process due to hedge fund manager’s need and desire to grow assets under management.

I would suggest managers proceed with caution in placing too much emphasis on Prime selection based on cap intro services. The feedback we tend to receive from managers is that it is often the case that introductions do not lead to an allocation or that introductions tend to reduce once the fund is signed with the prime.

Traditionally, managers have been overly reliant on raising AUM through cap intro services, however, for smaller fund launches, greater success is often achieved through the manager’s own independent networking. The cap intro part of a prime broker’s service offering is useful, and helpful, with little to no downside, but I think that having cap intro services as the primary driver of a new hedge fund manager’s prime broker selection is a little short sighted.

GW: Outsourcing is a term that is applicable to a range of departments within a fund. Tell us what areas emerging managers should be looking to outsource, and why.

SB: Emerging managers are facing increased headwinds in raising assets, maintaining existing AUM, performance fee generation and increased regulations, so absolutely, funds should consider outsourcing as a way of reducing costs and improving the portfolio manager’s time allocation. One way to manage regulatory costs is for emerging managers to place themselves with a fund manager platform to allow for a more efficient allocation of cost.

We have seen a marked increase in emerging managers outsourcing their front office by leveraging on the trading services provided by their Prime’s. At CGS-CIMB we provide multi-asset global trading coverage via our desks in Singapore and London. Whilst a high proportion of clients trade electronically via our low touch services, we are seeing our fund clients increasingly using our high touch services; our pricing optimisation for execution services allows emerging mangers to interchange between low touch and high touch execution services without incurring disparate rates in most tradeable markets.

GW: Many emerging managers believe they need to open an account with one of the large investment banks. What do new funds need to be conscious of here before taking that plunge?

SB: I think that the main considerations for a new hedge fund manager are the same whether they open an account with a large bank or a smaller provider. From the outset of initial conversations between Prime and fund, I think it’s critical that both parties are aligned and therefore understand their expectations. The revenue generation the Prime envisages from the fund, expected early stage AUM fund growth, the level of service/contact the fund anticipates from the Prime and the ways in which the Prime can best support the fund both operationally and trading are examples of where there needs to be alignment.

We see cases of funds selecting large Primes and then spending a disproportionate amount of time worrying about whether they are generating sufficient revenue for the Prime in order to maintain the relationship and bemoaning a lack of service and in these cases its very common that the manager and the prime haven’t drilled down enough into the expectations, on both. The relationship with a Prime Broker is a two-way street.

GW: Finally, what other advice would you give to new managers that we’ve not covered off here?

SB: Think carefully before selecting your prime broker. As I’ve mentioned previously the relationship between you and your prime broker is a two-way street. Selecting the right partner from the start will save you potential upheaval should you want or need to change your Prime. Instead of focusing on the cap intro part of the service, in my opinion, the key is to look for a prime that has “patient account minimums” to support your fund size in the early stages of growth.

Steve Bower is Director, Head of Sales, Prime Service (Europe) at CGS-CIMB

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