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Analyse This...Prime Brokerage

Posted 30 April 2005 - 12:00am by Visitor

Thanks to alternative investments such as hedge funds, the prime brokerage industry has not had a moment's rest. As this state of affairs looks set to continue, ISJ asks the experts what they see as the key trends in the alternative investment world...

Array

Jonas Lindgren
 

Comment on the rate of consolidation among prime brokers and fund servicing providers.

Answered by Jonas Lindgren, Securities Finance, SEB Merchant Banking

I predict further consolidation and co-operation between the prime brokers and the fund administrators. In other parts of the world, certain prime brokerage companies have bought fund administrators for a host of different reasons. Increasingly, the prime brokerage and fund administration industries are overlapping. Hedge fund managers are looking for an integrated solution with as few providers to provide these solutions as possible. The ability to integrate prime brokerage with net asset value calculation, performance fee calculation and taking care of the paying agent are important. Fund managers would like all of these services provided to them. An increasing number of prime brokers will begin to offer administration services as the ability to offer performance attributions continues to affect the prime brokerage industry. This could involve acquiring a fund administrator or linking up to an administrator for closer co-operation. Another alternative would be for the prime broker to build a fund administration business within the larger banking group.We have seen different examples of prime brokers who have set up their own fund administration capabilities in the US while others have chosen to domicile these services in Cayman. You will see more of this consolidation and co-operation among fund administrators and prime brokers. At the same time, the European authorities want to make onshore hedge fund domiciliation possible. This can be seen in France, Germany, Italy and Luxembourg. Financial institutions that would like to invest in hedge funds are restricted by board resolutions not to invest in offshore vehicles, restricting their ability to buy directly into offshore hedge funds. In Germany we have seen investors buying into hedge-linked bonds and other structured products in order to access the hedge funds market. Considering the new investment law in Germany, SEB can provide domestic investors with access to hedge funds investments.We can also give domestic hedge fund managers the infrastructure to create performance.

Array

Richard DelBello
 

How will the ability to offer value added services such as fund servicing and performance evaluation affect the prime brokerage industry in the future?

Answered by Richard DelBello, Head of Prime Brokerage Services for the Americas, UBS

One of the areas that are very interesting to hedge funds today is risk management. The more we can do to help them be aware of the risks of running their business the better.We use our abilities to manage risk for the client base and show them that we provide transparency in how we view the risk.

In turn, this service helps them analyse their own business in order to understand it better. Increasingly, we are all involved in outside services that are specialist and that can be driven by strategy as well as the product base that the client is involved in.

The service offering can get pretty specific, but everybody out there is looking at some way to help the client manage the risk as these hedge funds proliferate and as they individually grow their asset bases. Considering all of the things that a hedge fund needs, and a prime broker and hedge fund administrator provide, there is a moving line between those functions depending on the product offering.

But these services are all there and everybody needs them. The question is how much of it do you do yourself and to what extent do you partner with another institution to do it? Some prime brokers have entered the administration business and I can understand whey they would do that. We are also in this business but it is not part of our product offering specifically. It is a sister function within the bank and its delivery is largely dependent on pricing. Some people say, 'if I separate the administration service then maybe I can charge for it.' This may be the motivation for hosting an administration service within the investment bank. Scale is an important consideration in the prime brokerage industry. Ultimately, your ability to handle financings and to have a strong credit rating as a prime broker will become a more significant factor as the business matures.

 Array

Brian Bisesi

Comment on the importance of scale in the prime brokerage industry.

Answered by Brian Bisesi, Head of Prime Broker Marketing and Capital Introductions at Lehman Brothers

Scale is very important. The hedge funds industry continues to grow in the number of assets and the bulk of all new money goes to the established managers, especially in Europe. As these big managers get bigger, they need to expand their product offering, resulting in a trend where fixed income-only firms expand into equities or where equity-only firms expand into fixed income. A lot of these strategies are also melding into multi-strategies, including Capital Structure arbitrage, which is a very big asset class in the hedge fund industry. Henceforth, the need for a multi-asset class prime brokerage solution is now a very high priority for hedge fund managers. This multi-asset class solution includes the ability to clear, provide custody, finance (via margin or repo financing), report and provide risk management for equities, fixed income etc. Also covered is risk-based margining and providing the hedge fund with the most capital efficient solution across all asset classes. Capital Markets prime brokerage is very topical and is Lehman's key focus. As a given, all PB's offer clearing, custody and settlement services. Because scale is important, we have integrated all of our equity and fixed income prime brokerage services and listed derivative operations for both clearance and execution in London. We have also integrated our equity and fixed income financing business. As well as an equity prime broker offering securities lending and equity swaps, Lehman is also a fixed income repo counterparty for many of the banks and hedge funds that require bonds.We've merged these units under a common platform and can now leverage the fact that we're borrowing $2bn of equities from one counterparty and $3bn of fixed income from another. This adds to our significant prime brokerage franchise. Our electronic trading facility for equities and futures is included in our prime brokerage business.We believe the way forward is to package as many services for the client possible, while ensuring we service them, price their business and add value based on the holistic relationship they have with the firm across capital markets.

Array

Hamish Anderson 

Certain prime brokerage houses also provide custody services - does this set a standard for the community and is scale important?

Hamish Anderson, Director, Head of Prime Brokerage Sales, Dresdner Kleinwort Wasserstein

In an increasingly sophisticated and international hedge fund market, where the pressure is on fund managers to be ever more innovative and original in the quest for alpha and uncorrelated returns, it is vital that hedge fund service providers, and prime brokers in particular, have the wherewithal to support their clients comprehensively and cost effectively. DrKW's view is the ability to do this is more a question of expertise and infrastructure, however, than outright scale. Indeed, in certain cases, biggest may not always be best if systems, personnel and infrastructure have failed to evolve and grow commensurately with an expanding client base and changing client requirements. Equally, in today's environment it is no longer sufficient to boast scale according to a traditional equities prime brokerage model when a more diversified cross-asset class offering might be more in tune with clients' needs. As the hedge fund industry develops, it is ever more important, we argue, for a prime broker to be able to differentiate itself and to be judged in terms of its ability to service the strategy and potential of a particular fund - rather than to look solely at the value of assets managed and the length of the client roster. We therefore encourage clients to ask - can a prime broker accommodate all the assets, structures and markets that my fund will be trading this year, next year and the year after? The success of DrKW's Prime Brokerage service is testimony to the fact many hedge fund clients share this view - scale is no longer all in the industry. Custody is an important component of the prime brokerage offering, but it is a moot point as to whether all custody activities should be run exclusively in-house, or outsourced to local providers. The priority is to provide clients with access to a global network of custodians. To offer such a comprehensive in-house custody network would be inefficient, and something of a departure from our core strengths, so DrKW has opted to establish relationships with local custodians and sub-custodians in each of the markets in which our clients wish to operate.

Array

David Aldrich 

How far behind is automation within the buy side of the securities industry and how does this affect the prime brokers?

David Aldrich, Head of Securities Industry Banking, Europe, The Bank of New York

Automation is lacking in the hedge fund universe in several key areas: 1. The substantive absence of Swift ISO 15022 messaging for trade instruction between hedge funds and their prime brokers and custodians. 2. In fund of hedge fund investment processing, where the main forms of communication for trade subscriptions and redemptions has traditionally been the opposite of STP: fax, hard copy and telephone calls. 3. The use of complex derivatives for which standard message types are either inappropriate or not well adapted, means that in practise a 100 per cent STP rate is actually not achievable for funds which utilise complex OTC derivatives.

These factors are mitigated in several aspects: 1. The typical long short equity fund has very low trade volumes, in the low double digits, and therefore the low volumes make the poor STP rate less critical in operational impact. 2. Automation is available to managers through proprietary systems provided by both Prime Brokers and Global Custodians. 3. The impact varies enormously between small, medium and large hedge fund managers and most critically the difference is seen between the boutique managers and the traditional long only managers who have set up hedge fund businesses. 4. Administrators at the leading edge of technology implementation, such as The Bank of New York employ three-way daily reconciliations between the manager records, Prime Brokers and the portfolio records on the accounting system, SunGard's INVESTOne. This practise ensures that trade breaks items are highly controlled and the month end NAV process can therefore be delivered with 100 per cent confidence. 5. Automation of the fund of hedge fund subscription process has been dramatically revolutionised at The Bank of New York though the implementation of proprietary database and web technology. The benefits to managers are immediate and considerable, especially in the increased transparency and control of hedge fund investment transactions. 6. Many new "hedge" funds are hybrid versions of long only funds, perhaps with the addition of performance fees, and the automation available to these funds is nearly identical to those long only funds that they must closely resemble.

Array

Philippe Teilhard 

For the next five years, the hedge funds industry will be marked by increasing pressure to strengthen yields. Please comment

Answered by Philippe Teilhard, Managing Director, Fimat Global Fund Services

First off, it is true one of the parameters affecting the expected returns of hedge fund strategies as a whole is the actual amount of cash assets being managed by the industry. Although the relative rate of growth is diminishing, the absolute amount of capital coming in remains large as the industry asset base is now more important. This creates some capacity issues in certain trading opportunities. In this respect the strategies that will benefit are the directional ones - such as global macro, managed futures (CTA) and currency strategies.Markets will also be testing and somewhat difficult. But investors' objective remains the key to investment strategies. From time to time we observe trends that are sideways in nature. Interest rates will either go up or down prompting correlation factors in the marketplace of financial and hard assets to move. As challenging the market conditions may be, this is for skilful managers to position their investment strategy accordingly so as to extract returns to the benefit of their investors. Investors choosing the right hedge fund manager who understands the cycles in the market place and can trade accordingly have an edge. A macro approach to hedge fund investing seems unavoidable. If an asset manager's investment strategy profile is to be "long volatility" and the actual volatility in the market place or implied by financial instruments used by the fund manager collapse, it would be difficult to make money. Still, such an investment might be of use to an investor in relation to its overall portfolio holdings, for investors deciding between correlation attributes or absolute returns when investing in alternative investment is essential. Tools are available to allow investors to position themselves at different levels of the investment ladder. Even the funds of funds world is getting more polarised between passive and active management: on the one hand, the index based alternative investment managers who replicate an index such as the MCSI Hedge Fund Index or other dedicated alternative investment indices. On the other hand are the original funds of funds managers, who will probably increasingly need a more macro approach to investing. There are challenges, but a lot of opportunity for skilful people.

Array

Kevin Pollack

Will alternative investments such as fund of funds provide a panacea to the average returns delivered by the stock market?

Answered by Kevin A. Pollack, Buyside Partner, Resurrection Advisors (New York)

The hedge fund industry as a whole should continue to grow substantially in the next few years as returns in traditional markets have been disappointing and other alternative asset classes have been well-capitalised. However, despite industry growth, the growth potential of specific funds varies greatly and depends upon several factors, including asset size, track record, talent, quality of infrastructure, quality of investor base and strategy. In general, the largest funds have been enjoying economies of scale and attracting the most assets, even when their performance has been less than stellar. In contrast, many smaller funds, including those with excellent performance, have been facing substantial challenges to their growth. In our experience, many larger firms have been looking to buy or partner with smaller funds that have alpha-generating strategies and strong track records. These transactions can allow larger funds to add and retain proven talent more effectively than through hiring, enhance their returns, attract more assets from their investor network with the new strategies, cross-market to the smaller funds' investors, increase their asset base, leverage off of their platform and better establish themselves as one-stop shops to their investor base. Fund of fund investment is also likely to grow. First, funds of funds provide diversification and can reduce risk while providing consistent returns. Second, funds of funds can provide strong returns versus other asset classes given the unique nature of hedge funds. Third, funds of funds can be a one-stop shop in that investors can rely on them to perform all of the diligence required to successfully invest in the hedge fund space. Thus, to many investors, in addition to being a panacea to the stock market, investing in funds of funds may be preferable to investing in hedge funds. Although performance, track record, infrastructure and risk controls are among the most important factors for investors, when it comes to attracting significant assets, the old saying rings true: "size matters." Thus, many smaller funds of funds that lack a unique strategy may not have strong growth prospects. Consequently, we expect to see more Merger and Acquisitions / Joint Venture transactions in this space.

Array

Patrick Blessing 

 

What are the prospects for onshore prime brokerage providers?

Answered by Patrick Blessing, CFA, Equity Finance Sales, Scotia Capital

Recently we have seen a plethora of financial centres around the globe attempt to attract hedge funds to launch onshore rather than offshore. The pension and other institutional investors demanding onshore regulated structures, as well as an increasing interest in hedge funds from retail/private client investors have driven this trend. Hedge funds traditionally domiciled in offshore locations as tax rates and regulatory regimes were favourable to a quick launch and little ongoing regulatory involvement. The demand for hedge fund products from institutional investors has pushed many funds and new funds back onshore. Even though many offshore centres have increased their regulatory requirements they may still not meet the strict requirements of institutional investors. Where retail investors are concerned, offshore funds may not be an option for tax purposes. Generally we are seeing new funds launch with a "master feeder" structure that opens up the fund to onshore and offshore investors. The experience they have with the onshore and offshore components of the fund are very different depending on where they choose to domicile. From our perspective as prime broker, our service is the same for onshore or offshore funds, unless we are required to provide additional oversight or reporting to local regulators. This may increase our cost of providing our service in one market opposed to another, which ultimately increases the cost to the funds and their investors. This is the trade-off for a more regulated environment. Hedge fund managers launching onshore are often overwhelmed by the paperwork and bureaucracy involved receiving regulatory approval. In this area, we are often able to assist managers in the process of getting the fund launched by sharing our knowledge and experience. It is an intensive process but ultimately opens up the possibility for the growing demand by onshore investors. The "institutionalisation" of hedge funds will continue as long as the demand for onshore products continues. Likewise we expect to see more institutional investors such as pension funds and mutual funds increasingly act like hedge funds. As a leading prime broker and securities dealer we will continue to work with regulatory bodies in all markets wherever we can add value.

Comment on the rate of consolidation among prime brokers and fund servicing providers.

Body

Thanks to alternative investments such as hedge funds, the prime brokerage industry has not had a moment's rest. As this state of affairs looks set to continue, ISJ asks the experts what they see as the key trends in the alternative investment world...

Array

Jonas Lindgren
 

Comment on the rate of consolidation among prime brokers and fund servicing providers.

Answered by Jonas Lindgren, Securities Finance, SEB Merchant Banking

I predict further consolidation and co-operation between the prime brokers and the fund administrators. In other parts of the world, certain prime brokerage companies have bought fund administrators for a host of different reasons. Increasingly, the prime brokerage and fund administration industries are overlapping. Hedge fund managers are looking for an integrated solution with as few providers to provide these solutions as possible. The ability to integrate prime brokerage with net asset value calculation, performance fee calculation and taking care of the paying agent are important. Fund managers would like all of these services provided to them. An increasing number of prime brokers will begin to offer administration services as the ability to offer performance attributions continues to affect the prime brokerage industry. This could involve acquiring a fund administrator or linking up to an administrator for closer co-operation. Another alternative would be for the prime broker to build a fund administration business within the larger banking group.We have seen different examples of prime brokers who have set up their own fund administration capabilities in the US while others have chosen to domicile these services in Cayman. You will see more of this consolidation and co-operation among fund administrators and prime brokers. At the same time, the European authorities want to make onshore hedge fund domiciliation possible. This can be seen in France, Germany, Italy and Luxembourg. Financial institutions that would like to invest in hedge funds are restricted by board resolutions not to invest in offshore vehicles, restricting their ability to buy directly into offshore hedge funds. In Germany we have seen investors buying into hedge-linked bonds and other structured products in order to access the hedge funds market. Considering the new investment law in Germany, SEB can provide domestic investors with access to hedge funds investments.We can also give domestic hedge fund managers the infrastructure to create performance.

Array

Richard DelBello
 

How will the ability to offer value added services such as fund servicing and performance evaluation affect the prime brokerage industry in the future?

Answered by Richard DelBello, Head of Prime Brokerage Services for the Americas, UBS

One of the areas that are very interesting to hedge funds today is risk management. The more we can do to help them be aware of the risks of running their business the better.We use our abilities to manage risk for the client base and show them that we provide transparency in how we view the risk.

In turn, this service helps them analyse their own business in order to understand it better. Increasingly, we are all involved in outside services that are specialist and that can be driven by strategy as well as the product base that the client is involved in.

The service offering can get pretty specific, but everybody out there is looking at some way to help the client manage the risk as these hedge funds proliferate and as they individually grow their asset bases. Considering all of the things that a hedge fund needs, and a prime broker and hedge fund administrator provide, there is a moving line between those functions depending on the product offering.

But these services are all there and everybody needs them. The question is how much of it do you do yourself and to what extent do you partner with another institution to do it? Some prime brokers have entered the administration business and I can understand whey they would do that. We are also in this business but it is not part of our product offering specifically. It is a sister function within the bank and its delivery is largely dependent on pricing. Some people say, 'if I separate the administration service then maybe I can charge for it.' This may be the motivation for hosting an administration service within the investment bank. Scale is an important consideration in the prime brokerage industry. Ultimately, your ability to handle financings and to have a strong credit rating as a prime broker will become a more significant factor as the business matures.

 Array

Brian Bisesi

Comment on the importance of scale in the prime brokerage industry.

Answered by Brian Bisesi, Head of Prime Broker Marketing and Capital Introductions at Lehman Brothers

Scale is very important. The hedge funds industry continues to grow in the number of assets and the bulk of all new money goes to the established managers, especially in Europe. As these big managers get bigger, they need to expand their product offering, resulting in a trend where fixed income-only firms expand into equities or where equity-only firms expand into fixed income. A lot of these strategies are also melding into multi-strategies, including Capital Structure arbitrage, which is a very big asset class in the hedge fund industry. Henceforth, the need for a multi-asset class prime brokerage solution is now a very high priority for hedge fund managers. This multi-asset class solution includes the ability to clear, provide custody, finance (via margin or repo financing), report and provide risk management for equities, fixed income etc. Also covered is risk-based margining and providing the hedge fund with the most capital efficient solution across all asset classes. Capital Markets prime brokerage is very topical and is Lehman's key focus. As a given, all PB's offer clearing, custody and settlement services. Because scale is important, we have integrated all of our equity and fixed income prime brokerage services and listed derivative operations for both clearance and execution in London. We have also integrated our equity and fixed income financing business. As well as an equity prime broker offering securities lending and equity swaps, Lehman is also a fixed income repo counterparty for many of the banks and hedge funds that require bonds.We've merged these units under a common platform and can now leverage the fact that we're borrowing $2bn of equities from one counterparty and $3bn of fixed income from another. This adds to our significant prime brokerage franchise. Our electronic trading facility for equities and futures is included in our prime brokerage business.We believe the way forward is to package as many services for the client possible, while ensuring we service them, price their business and add value based on the holistic relationship they have with the firm across capital markets.

Array

Hamish Anderson 

Certain prime brokerage houses also provide custody services - does this set a standard for the community and is scale important?

Hamish Anderson, Director, Head of Prime Brokerage Sales, Dresdner Kleinwort Wasserstein

In an increasingly sophisticated and international hedge fund market, where the pressure is on fund managers to be ever more innovative and original in the quest for alpha and uncorrelated returns, it is vital that hedge fund service providers, and prime brokers in particular, have the wherewithal to support their clients comprehensively and cost effectively. DrKW's view is the ability to do this is more a question of expertise and infrastructure, however, than outright scale. Indeed, in certain cases, biggest may not always be best if systems, personnel and infrastructure have failed to evolve and grow commensurately with an expanding client base and changing client requirements. Equally, in today's environment it is no longer sufficient to boast scale according to a traditional equities prime brokerage model when a more diversified cross-asset class offering might be more in tune with clients' needs. As the hedge fund industry develops, it is ever more important, we argue, for a prime broker to be able to differentiate itself and to be judged in terms of its ability to service the strategy and potential of a particular fund - rather than to look solely at the value of assets managed and the length of the client roster. We therefore encourage clients to ask - can a prime broker accommodate all the assets, structures and markets that my fund will be trading this year, next year and the year after? The success of DrKW's Prime Brokerage service is testimony to the fact many hedge fund clients share this view - scale is no longer all in the industry. Custody is an important component of the prime brokerage offering, but it is a moot point as to whether all custody activities should be run exclusively in-house, or outsourced to local providers. The priority is to provide clients with access to a global network of custodians. To offer such a comprehensive in-house custody network would be inefficient, and something of a departure from our core strengths, so DrKW has opted to establish relationships with local custodians and sub-custodians in each of the markets in which our clients wish to operate.

Array

David Aldrich 

How far behind is automation within the buy side of the securities industry and how does this affect the prime brokers?

David Aldrich, Head of Securities Industry Banking, Europe, The Bank of New York

Automation is lacking in the hedge fund universe in several key areas: 1. The substantive absence of Swift ISO 15022 messaging for trade instruction between hedge funds and their prime brokers and custodians. 2. In fund of hedge fund investment processing, where the main forms of communication for trade subscriptions and redemptions has traditionally been the opposite of STP: fax, hard copy and telephone calls. 3. The use of complex derivatives for which standard message types are either inappropriate or not well adapted, means that in practise a 100 per cent STP rate is actually not achievable for funds which utilise complex OTC derivatives.

These factors are mitigated in several aspects: 1. The typical long short equity fund has very low trade volumes, in the low double digits, and therefore the low volumes make the poor STP rate less critical in operational impact. 2. Automation is available to managers through proprietary systems provided by both Prime Brokers and Global Custodians. 3. The impact varies enormously between small, medium and large hedge fund managers and most critically the difference is seen between the boutique managers and the traditional long only managers who have set up hedge fund businesses. 4. Administrators at the leading edge of technology implementation, such as The Bank of New York employ three-way daily reconciliations between the manager records, Prime Brokers and the portfolio records on the accounting system, SunGard's INVESTOne. This practise ensures that trade breaks items are highly controlled and the month end NAV process can therefore be delivered with 100 per cent confidence. 5. Automation of the fund of hedge fund subscription process has been dramatically revolutionised at The Bank of New York though the implementation of proprietary database and web technology. The benefits to managers are immediate and considerable, especially in the increased transparency and control of hedge fund investment transactions. 6. Many new "hedge" funds are hybrid versions of long only funds, perhaps with the addition of performance fees, and the automation available to these funds is nearly identical to those long only funds that they must closely resemble.

Array

Philippe Teilhard 

For the next five years, the hedge funds industry will be marked by increasing pressure to strengthen yields. Please comment

Answered by Philippe Teilhard, Managing Director, Fimat Global Fund Services

First off, it is true one of the parameters affecting the expected returns of hedge fund strategies as a whole is the actual amount of cash assets being managed by the industry. Although the relative rate of growth is diminishing, the absolute amount of capital coming in remains large as the industry asset base is now more important. This creates some capacity issues in certain trading opportunities. In this respect the strategies that will benefit are the directional ones - such as global macro, managed futures (CTA) and currency strategies.Markets will also be testing and somewhat difficult. But investors' objective remains the key to investment strategies. From time to time we observe trends that are sideways in nature. Interest rates will either go up or down prompting correlation factors in the marketplace of financial and hard assets to move. As challenging the market conditions may be, this is for skilful managers to position their investment strategy accordingly so as to extract returns to the benefit of their investors. Investors choosing the right hedge fund manager who understands the cycles in the market place and can trade accordingly have an edge. A macro approach to hedge fund investing seems unavoidable. If an asset manager's investment strategy profile is to be "long volatility" and the actual volatility in the market place or implied by financial instruments used by the fund manager collapse, it would be difficult to make money. Still, such an investment might be of use to an investor in relation to its overall portfolio holdings, for investors deciding between correlation attributes or absolute returns when investing in alternative investment is essential. Tools are available to allow investors to position themselves at different levels of the investment ladder. Even the funds of funds world is getting more polarised between passive and active management: on the one hand, the index based alternative investment managers who replicate an index such as the MCSI Hedge Fund Index or other dedicated alternative investment indices. On the other hand are the original funds of funds managers, who will probably increasingly need a more macro approach to investing. There are challenges, but a lot of opportunity for skilful people.

Array

Kevin Pollack

Will alternative investments such as fund of funds provide a panacea to the average returns delivered by the stock market?

Answered by Kevin A. Pollack, Buyside Partner, Resurrection Advisors (New York)

The hedge fund industry as a whole should continue to grow substantially in the next few years as returns in traditional markets have been disappointing and other alternative asset classes have been well-capitalised. However, despite industry growth, the growth potential of specific funds varies greatly and depends upon several factors, including asset size, track record, talent, quality of infrastructure, quality of investor base and strategy. In general, the largest funds have been enjoying economies of scale and attracting the most assets, even when their performance has been less than stellar. In contrast, many smaller funds, including those with excellent performance, have been facing substantial challenges to their growth. In our experience, many larger firms have been looking to buy or partner with smaller funds that have alpha-generating strategies and strong track records. These transactions can allow larger funds to add and retain proven talent more effectively than through hiring, enhance their returns, attract more assets from their investor network with the new strategies, cross-market to the smaller funds' investors, increase their asset base, leverage off of their platform and better establish themselves as one-stop shops to their investor base. Fund of fund investment is also likely to grow. First, funds of funds provide diversification and can reduce risk while providing consistent returns. Second, funds of funds can provide strong returns versus other asset classes given the unique nature of hedge funds. Third, funds of funds can be a one-stop shop in that investors can rely on them to perform all of the diligence required to successfully invest in the hedge fund space. Thus, to many investors, in addition to being a panacea to the stock market, investing in funds of funds may be preferable to investing in hedge funds. Although performance, track record, infrastructure and risk controls are among the most important factors for investors, when it comes to attracting significant assets, the old saying rings true: "size matters." Thus, many smaller funds of funds that lack a unique strategy may not have strong growth prospects. Consequently, we expect to see more Merger and Acquisitions / Joint Venture transactions in this space.

Array

Patrick Blessing 

 

What are the prospects for onshore prime brokerage providers?

Answered by Patrick Blessing, CFA, Equity Finance Sales, Scotia Capital

Recently we have seen a plethora of financial centres around the globe attempt to attract hedge funds to launch onshore rather than offshore. The pension and other institutional investors demanding onshore regulated structures, as well as an increasing interest in hedge funds from retail/private client investors have driven this trend. Hedge funds traditionally domiciled in offshore locations as tax rates and regulatory regimes were favourable to a quick launch and little ongoing regulatory involvement. The demand for hedge fund products from institutional investors has pushed many funds and new funds back onshore. Even though many offshore centres have increased their regulatory requirements they may still not meet the strict requirements of institutional investors. Where retail investors are concerned, offshore funds may not be an option for tax purposes. Generally we are seeing new funds launch with a "master feeder" structure that opens up the fund to onshore and offshore investors. The experience they have with the onshore and offshore components of the fund are very different depending on where they choose to domicile. From our perspective as prime broker, our service is the same for onshore or offshore funds, unless we are required to provide additional oversight or reporting to local regulators. This may increase our cost of providing our service in one market opposed to another, which ultimately increases the cost to the funds and their investors. This is the trade-off for a more regulated environment. Hedge fund managers launching onshore are often overwhelmed by the paperwork and bureaucracy involved receiving regulatory approval. In this area, we are often able to assist managers in the process of getting the fund launched by sharing our knowledge and experience. It is an intensive process but ultimately opens up the possibility for the growing demand by onshore investors. The "institutionalisation" of hedge funds will continue as long as the demand for onshore products continues. Likewise we expect to see more institutional investors such as pension funds and mutual funds increasingly act like hedge funds. As a leading prime broker and securities dealer we will continue to work with regulatory bodies in all markets wherever we can add value.