Why hedge funds need prime brokers

Sarshnee Pather, Absa Prime

The relationship between a hedge fund and its prime broker is a symbiotic one – with a bespoke suite of services required to help hedge fund managers deliver on their investment strategies. Prime brokerage is a term that refers to the suite of services offered to hedge fund managers and other institutional investors. These services include a wide variety of custodial and financial services that prime brokers offer their hedge fund clients. 

The range of services includes:

  • Consolidation and aggregation of trading risk: Hedge funds are able to trade with multiple counterparties across the street and give in those trades to their prime broker, providing the managers with a consolidated view of portfolio risk 
  • Access to leverage: Prime brokers provide their clients with access to portfolio gearing through cash loans or synthetic financing (via swap) to enhance returns 
  • Securities lending: Prime brokers assist hedge funds in securing borrow for stocks they wish to short. This is done via pre-agreed borrow limits or a request to the securities lending desk to source on the manager’s behalf
  • Providing access to research: Prime brokers typically have extensive research departments that produce research reports which hedge funds consume. This research is made available to hedge funds when they become a client of prime broker 
  • Helping hedge funds to identify new investors: Prime brokers can offer capital introduction services whereby they match hedge fund clients with potential capital allocators 
  • Custodial services: Prime brokers hold hedge fund assets in custody, thereby facilitating a smooth transfer of assets post execution 

Collateral management and financing: Prime brokers offer competitive and dynamic margin finance models to support the hedge fund in achieving its investment mandate 

  • Settlement and clearing: Prime brokers offer integrated clearing and settlement services, ensuring cash and securities are settled timeously 
  • Reporting capabilities: Prime brokers need a robust reporting platform to deliver risk and performance reports for consumption and integration by the hedge fund manager and third-party service providers. 

Given the critical role the prime brokerage plays as a financial intermediary, it is important that hedge fund managers consider key elements when selecting a prime broker. 

Market and asset class coverage: As fund managers search for opportunities, they need to ensure that they are able to access a full suite of asset classes and markets, including equities, FX, commodities and fixed income 

  • Comprehensive technology offering: Look for direct market access (DMA) infrastructure supporting low latency access for efficient execution. Co-location solutions and customised algorithms are important differentiators for hedge fund managers in the execution of their strategy. More importantly, is the prime broker in touch with technological advancements which hedge fund managers can leverage to boost alpha generation?
  • Extensive balance sheet: Hedge fund managers should consider the creditworthiness of prime brokers on an ongoing basis to ensure trading activities are unhindered. It is recommended hedge fund managers should diversify portfolio exposure across multiple prime brokers to strengthen returns and mitigate risks
  • Integrated services: Ensure the prime broker can provide a consolidation of clearing and financing solutions across instruments with sound operational infrastructure underpinning this
  • Securities inventory: Look for easy access to securities inventory including holders of less liquid or more difficult to borrow securities

The relationship between the hedge fund and prime broker is mutually beneficial – the growth and success of the hedge fund ensures that that the prime broker will prosper through increased revenue in financing spreads and execution revenue. Equally so, the strength in the prime broker will allow the hedge fund manager to focus on the delivery of the investment strategy rather than being distracted by other non-investment risks. Copyright. HedgeNews Africa – October 2022.

Sarshnee has a Masters in Business Administration (MBA) and a Bachelor of Commerce (auditing and accounting) from the University of Pretoria’s Gordon Institute of Business Science and the University of Kwa-Zulu Natal respectively. Sarshnee began her investment banking career in accountant roles at UBS, Rand Merchant Bank (RMB) and CitiBank. Prior to her current role with Absa Prime, client relationships, Sarshnee fulfilled the COO function as business manager for the markets, trading and sales desks, FICC, structuring and syndication. During her time at Absa, she has been involved in building a leading secondary markets business by driving product innovation and operational efficiencies to sell domestic and international products to South African and African corporate and institutional investors.