Why Use Prime Brokers?
- Thread starter prudent
- Start date
Interesting, another benefit of prime brokers is the perks they offer like free bloomberg, office furniture, and even office space. I would think that the level of perks depends on the size of your account and your trading volume with them.
Do the smaller prime brokers that you mentioned offer any perks (e.g., free bloomberg) for a $1 million account?
Do the smaller prime brokers that you mentioned offer any perks (e.g., free bloomberg) for a $1 million account?
Prudent,
The reason why a hedge fund with $1 million under management would want to use a prime broker is because the prime broker
can get you clients. This is the main reason why hedge funds use prime brokers. A firm such as Bear Stearns or Goldman will sell itself by saying that it can get you hedge fund clients. Since i-banks have a private client division, they will know plenty of wealthy investors. Of course, in exchange for referring clients, they expect you to trade through them even though their commission rates are not cheap. The hedge fund benefits not only from any clients that are the introduced by the broker, but also from the air of legitimacy that an investment bank can give. Clients think that if you clear through Bear Stearns, you are less likely to cheat them. There was a Forbes article a few years back titled "Bear Stearns and Bucket Shops" that mentions this.
Is this best for the client? Of course not, since the client ends up paying higher commissions. But many clients don't understand this.
Is this good for the hedge fund? In many cases, yes. It is not
easy to raise money, even with good performance. One way is to use a 3rd party marketer, who will charge anywhere from 20%-50% of the fees collected. The other way (the cheaper way) is to
trade commissions in exchange for clients. This way, the money is coming out of the pockets of the clients, not the hedge fund owner(s).
Ideally, a hedge fund would get clients based solely on its outstanding performance, while getting the best commission deal possible for its clients. Since the performance is great, money would be pouring in, and there would be no need to charge the clients a higher commission rate in exchange for finding the clients. Ideally, the fact that the hedge fund was looking out for its clients by getting a great commission deal would be sufficient marketing. Of course, we don't live in an ideal world, do we?
The reason why a hedge fund with $1 million under management would want to use a prime broker is because the prime broker
can get you clients. This is the main reason why hedge funds use prime brokers. A firm such as Bear Stearns or Goldman will sell itself by saying that it can get you hedge fund clients. Since i-banks have a private client division, they will know plenty of wealthy investors. Of course, in exchange for referring clients, they expect you to trade through them even though their commission rates are not cheap. The hedge fund benefits not only from any clients that are the introduced by the broker, but also from the air of legitimacy that an investment bank can give. Clients think that if you clear through Bear Stearns, you are less likely to cheat them. There was a Forbes article a few years back titled "Bear Stearns and Bucket Shops" that mentions this.
Is this best for the client? Of course not, since the client ends up paying higher commissions. But many clients don't understand this.
Is this good for the hedge fund? In many cases, yes. It is not
easy to raise money, even with good performance. One way is to use a 3rd party marketer, who will charge anywhere from 20%-50% of the fees collected. The other way (the cheaper way) is to
trade commissions in exchange for clients. This way, the money is coming out of the pockets of the clients, not the hedge fund owner(s).
Ideally, a hedge fund would get clients based solely on its outstanding performance, while getting the best commission deal possible for its clients. Since the performance is great, money would be pouring in, and there would be no need to charge the clients a higher commission rate in exchange for finding the clients. Ideally, the fact that the hedge fund was looking out for its clients by getting a great commission deal would be sufficient marketing. Of course, we don't live in an ideal world, do we?
Nice post - sounds like you 'been there done that.'
People mentioned that Prime brokers can introduce PE investors to their client hedge funds.
But I am wondering .... can Prime brokers also provide increased leverage or more flexible margining in the form of loans or some type of creative financing?
For instance I recall that LTCM was leveraged some ungodly amount, like 50x1 or something crazy like that through the use of some type of float or loans ... Do prime brokers facilitate that kind of positioning?
Yes, the investment banks do try to sell a few other services that they provide, such as financing, the ability to borrow stock to short, and consolidated brokerage statements. But I think these
are pretty much the same at all investment banks. The best way for them to differentiate themselves is by telling the hedge fund manager that they can get your fund above some threshold ($10 - $50 million) necessary to attract large institutional money.
As far as the leverage, my guess is that LTCM's margin-to-equity ratio was much higher than most other hedge funds. One of the first metrics investors look at is the margin-to-equity, and a number that is very high would cause concern. Of course, it would also depend on the strategy.
are pretty much the same at all investment banks. The best way for them to differentiate themselves is by telling the hedge fund manager that they can get your fund above some threshold ($10 - $50 million) necessary to attract large institutional money.
As far as the leverage, my guess is that LTCM's margin-to-equity ratio was much higher than most other hedge funds. One of the first metrics investors look at is the margin-to-equity, and a number that is very high would cause concern. Of course, it would also depend on the strategy.
jerryz,
I ran a hedge fund with AUM in the low eight figures, and I never
found it necessary to talk to a prime broker.
Some prime brokers are more selective than others. Last I heard, Goldman Sachs required at least $50 million. A firm such as Furman Selz takes on much smaller hedge funds. I think the main things a prime broker will look at is what is your AUM and
how much business can you give them.
But I was able to raise money without using a prime broker. For me, it was not whether the prime broker would take me on, but whether I wanted one (I didn't).
I would say focus on delivering great performance, and you will not need anything else in order to raise money.
Of course, this is just my experience.
I ran a hedge fund with AUM in the low eight figures, and I never
found it necessary to talk to a prime broker.
Some prime brokers are more selective than others. Last I heard, Goldman Sachs required at least $50 million. A firm such as Furman Selz takes on much smaller hedge funds. I think the main things a prime broker will look at is what is your AUM and
how much business can you give them.
But I was able to raise money without using a prime broker. For me, it was not whether the prime broker would take me on, but whether I wanted one (I didn't).
I would say focus on delivering great performance, and you will not need anything else in order to raise money.
Of course, this is just my experience.
Out here in Asia, and depending on what strategies one is pursuing, I would imagine the services of a Prime broker could be more valuable, particularly when it comes to trading OTC securities and trading directly in several emerging markets simultaneously ...
I can use capital introduction so I'm trying to get a sense of what's realistic. Would you say that there are any small but reputable prime brokers out there who will take $1 million AUM?
The problem with great performance is that different people define it differently. I find that individuals care a lot less about risk-adjusted returns than institutions do. They really just want you to give them a large return on their investment. Since you have to raise money from individuals in the beginning, you have to invest in such a way that generates those large returns at the cost of a lower Sharpe ratio. However, when you have enough critical mass to raise institutional money, your track record will be less desirable because of the low Sharpe. What can you do? Short-run vs long-run. Maybe your experience has been different.
The problem with great performance is that different people define it differently. I find that individuals care a lot less about risk-adjusted returns than institutions do. They really just want you to give them a large return on their investment. Since you have to raise money from individuals in the beginning, you have to invest in such a way that generates those large returns at the cost of a lower Sharpe ratio. However, when you have enough critical mass to raise institutional money, your track record will be less desirable because of the low Sharpe. What can you do? Short-run vs long-run. Maybe your experience has been different.
BlueHorseshoe,
Interesting. I can see that being the case in Asia. But, I would like to draw a distinction between the investment bank acting as a broker and the prime brokerage subsidiary. A hedge fund could always trade through the investment bank without using the prime brokerage services of the investment bank.
Interesting. I can see that being the case in Asia. But, I would like to draw a distinction between the investment bank acting as a broker and the prime brokerage subsidiary. A hedge fund could always trade through the investment bank without using the prime brokerage services of the investment bank.