Prime brokers rise to the challenge as funds seek stability and service

By Jack Seibald, TD Cowen

Published: 20 March 2023

The prime brokerage sector has been through turbulent times but has reset with a renewed determination to help funds meet their goals. Jack Seibald, Managing Director, Co-Head of TD Cowen Prime Execution Services at TD Cowen discusses the value, service and stability that a partnership with the right prime broker can bring.

Prime brokers provide an array of institutional services that can be customised to meet the individual needs of investment managers at any stage of their business. These include trade execution and custody, middle and back-office support, securities lending and portfolio financing. There are two services areas in particular which will get a lot of attention this year - outsourced trading and capital introduction. Demand for these services are expected to accelerate throughout 2023 and beyond.

Outsourced trading

Outsourced trading is just one of the many functions fund managers are adopting in the search for efficiencies, access to expertise, and operational excellence. Once viewed with suspicion by institutional investors and larger hedge fund managers, outsourcing is now considered a wise move for fund managers, especially in a time of tight budgets, falling AUM and flattened fees. 

Some funds outsource to rein in costs, while others see it as an efficient way to access services, resources and expertise to help them grow. It’s also tried and tested way to extend their reach by trading in unfamiliar assets or geographies. 

Outsourced trading is an attractive proposition because it is so flexible – for example, TD Cowen’s solution can be a high-touch, complete outsourced trading solution, or simply supplement an existing trading operation. The service gives fund managers access to an established and experienced team of ‘buy-side’ traders, support staff, and trading and reporting infrastructure in addition to the existing relationships developed over the years with scores of institutional brokers that provide research, corporate access, and capital markets flows.

The solution also offers exceptional value to investment managers as it truly functions as the client’s trading desk but avoids the cost of building and operating an in-house trading infrastructure. 

Capital introduction 

Cap intro is another service offered by prime brokers which is in the spotlight in 2023, particularly among emerging fund managers. Global investors withdrew US$55.4 billion dollars from hedge funds in 2022, according to HFR data, so if you are seeking investment, prime brokers with a cap intro specialism can play a significant role in bringing together emerging managers and early stage investors, including family offices, fund of funds, endowments and foundations. 

Select a prime broker with a team who have strong allocator backgrounds and can therefore provide a high level of insight and guidance to fund managers seeking investment. 

The calibre of the team, combined with the breadth of the prime broker’s access to potential investors should be a key criterion for managers looking to partner with a prime broker.

Leaders in this service conduct a rigorous analysis of potential investors before introducing them to their investor clients to ensure their expectations are compatible. This results in greater success rates.

Selecting the right prime broker

What fund managers are looking for from their prime broker depends on their specific needs – a fund at an early stage of growth might look to a prime broker for capital introduction, whereas a more seasoned firm might be more interested in outsourced trading or expertise in a different asset class. Whatever their needs, it is important to select a prime broker for the fund manager’s current and future needs. I have three key recommendations for fund managers:

1)    Look at the capabilities, not the size: Many fund managers may initially look to bulge-bracket banks for prime brokerage services. Their global reach and reputations make them highly attractive for fund managers, and this is not expected to change. However, there is an argument that a prime broker’s size is less important than it was. The priority for a fund manager is to work with a prime broker that offers capabilities to match those required by the client, particularly if those capabilities match what the bulge-bracket banks offer but are also combined with very high levels of service. 
Be mindful that some larger prime brokers can demand certain levels of revenue from the relationship, and might down-grade or even off-board a client who misses the target. With this in mind, it seems likely that more fund managers will increasingly explore the solutions offered by mid-sized prime brokers.

2)   Track record is key: In addition to considering the breadth of services on offer, select a prime broker with a sound record of performance, longevity of experience in the business and commitment to their clients. Given the current climate, it’s also important to ascertain if the prime broker has experience of working through seismic shifts in the global economy.

    As part of your due diligence, check the strength of the prime broker’s risk management. Given the recent steep losses experienced by some prime brokers, regulators have reviewed risk management measures at banks providing such services, warning them to invest in their risk management framework and control infrastructure.

3)    Add value with complementary prime brokers: There is an increasing trend towards partnering with several prime brokers and, in particular, diversifying by engaging non-bulge bracket firms, especially those with the right capabilities and a strong focus on providing high levels of service. Given the recent upheaval in the market, having multiple prime brokers provides fund managers with the security, stability, consistency and the full range of services they need to grow their businesses. 

    Irrespective of a prime broker’s size, adding a second or third prime broker brings many benefits. Fund managers gain access to different product offerings, allowing them to either complement those of its current partner or to fill gaps. With the right prime broker, they might also experience more attention and focus on their needs. A less tangible but important benefit is that with more prime brokers come more perspectives on the markets and more opportunities to access useful advice.

Above all, my final piece of advice, is do your due diligence carefully and select your stable of prime brokers who will evolve with you as your business grows and can help to plug any gaps you may have along the way.