Prime Brokerage Client Services

After the sales force brings hedge funds onto the Prime Brokerage platform, the client is handed off to the Client Services Team for day-to-day management.  It is here that clear and accurate knowledge transfer of the client's needs and goals is vital.  The Client Services representative must know everything.  They will be the fund's advocate and problem solvers for the different capabilities within Prime Brokerage.  These include custody and trade settlement, financing on margin, risk management and accurate reporting of portfolio and positions on a real-time basis.  Most of their day is acting on issues on behalf of their client.

Some firms add a senior executive as a relationship manager.  They serve as an additional advocate for the fund as reinforcement for the Client Services representative.

Prime Brokerage Sales

Prime Brokerage Sales, also known as Hedge Fund Sales, concentrate on bringing new funds onto the investment bank's platform.  They may be new start-up funds or a new fund being launched by a successful organization.

Hedge Fund Sales is selling the capabilities of the bank; tailoring their pitch to the hedge fund's needs.  The fund may be interested in getting access to algorithmic trading or trading in global markets or have special trade settlement and clearing needs.  There may have been an existing relationship between the fund and bank through the Capital Introductions or Hedge Fund Services Teams.  If these prior touchpoints were positive, then the bank would have a headstart in bringing the fund onboard.

Helping Emerging Hedge Funds

The Prime Brokerage Division of Investment Banks helps seed emerging hedge funds through the Capital Introductions team.  There is another team - Hedge Fund Services - that helps start-up funds with the details and logistics of launching the fund.  They help the fund find office space and set up the nuts and bolts of the office i.e. computers, Bloomberg terminals, phones, office furniture and supplies.  The team has a contact list of specialists:  accountants, lawyers, operations and technology professionals, etc. that will work closely with the fund manager.

After the fund has been established and is growing (in assets and people), then Hedge Fund Services will aid in additional areas such as Human Resources or business development.  Like Capital Introductions, there is no explicit fee for this service but it binds the relationship between prime broker and hedge fund even tighter.

Capital Introductions

In the prior entry, I had introduced prime brokers and the special services they give hedge funds.  This affects the entire life cycle of setting up a fund.  One of the services is Capital Introductions.  It is how fund managers meet investors.  The Capital Introductions Team runs an event or round table where managers seeking seed money to initiate their fund meet institutions who are seeking to invest with the best and brightest managers.  The event is run very much like a conference.  The team does its best to match up the managers and investors with the proper investing strategy i.e. a risk averse investor would meet with an equity market neutral manager.  After the event, they would gather feedback from the investors regarding their level of interest for a manager and forward the information.  The two interested parties will then follow-up with each other.

There is no fee paid to Capital Introductions.  This is different than if the investment had been completed through, for example, the Alternative Investment Division.  In the latter case, there is a fee paid to the investment bank.

Hedge Funds

The broker vote is not as reliable a forecaster of market share for hedge funds as for mutual and pension funds.  A hedge fund should have at least 2-3 prime brokers.  These brokers supply financial services such as custody services, securities lending and financing.  We will tackle these items at a later date.  The world of prime brokers used to be dominated by Goldman Sachs, Morgan Stanley and, to a lesser extent, Bear Stearns.  Since the financial crisis in 2008, the space has added Credit Suisse and Deutsche Bank.  JP Morgan has replaced Bear Stearns because of its acquisition.  Please reference this March 2010 article for a fuller understanding of the players.  These prime brokers are also sell side firms.  Since there are already strong existing relationships between hedge funds and their brokers, the market share for hedge fund commissions are skewed in favor of them and may not follow the results of the broker vote.

Anatomy of a Broker Vote

Sample Broker Vote:

We have maintained our #3 position with ABC Management Company in first half of 2010 (In the prior voting period, we were also #3).
Few highlights:

Our breadth of coverage with ABC Management Company is good...
There are 8 analysts who vote in New York, 4-5 in London (the number depends on the US-related projects). For the first half of 2010, only 2 analysts did not vote for us.  We are doing better than the competition.

...however our depth needs improvement.
Compared to the competitors, number of points we get from each analyst is low, according to the CIO i.e. we have fewer #1 rated analysts. As a benchmark, high single digit point is good, double-digit points are considered excellent (analysts and PM's allocate 100 points). We had 2 analysts who gave us double-digit points.

Overall ranking #3, but the upside to #1 is still big.
Top 3 gets roughly 40% of the commission market share. #1 broker gets in the high teens, while #3 gets 10%.  In absolute commissions, 8% difference is equal to around US $1m.  Biggest vote upside will come from the 2 analysts who did not vote for us.

Overall competitive landscape:
* Commission shares looks much like an S-curve. Top 3 gets roughly 40% of the commissions, while there is very little market share difference for #4-9.  1-2% difference between #4 and #9.  Top 10 gets close to 75%.  Broker universe has expanded as good analysts from big firms move to smaller houses or boutiques and ABC's analysts want access.  However, they are paid minimal amounts. Analysts usually vote for 10-15 brokers.

Overall updates on ABC Management Company:
* $7-8 B in assets under management
* Tougher 2Q, but July looking better overall.  Seeing stablilization of clients flow.
* Investment making process is a bottoms-up: each analyst talks to the portfolio manager when there are an actionable investment ideas and PM will make the final decisions on the stock.

ACTION POINTS:
* Introduction of credit analyst to John Smith
* Introduction of Thomas Jones to new technology analyst
* Establish solid relationship with Allan Edwards

Reasons the Sell Side Would Vote for an Analyst

Each sell side voter and firm has its own investing philosophy.  Naturally, during voting season, they have different reasons for giving an analyst a vote.  These may be:
1.  Making a good call for buying or selling a stock
2.  Having insights into their industry or stocks
3.  Taking the trouble to meet with them personally (This applies especially for clients not in New York, Boston, California or London.)
4.  Having an interesting/fresh investment thesis
5.  Sponsoring access with corporate management via a conference, field trip or roadshow

Issuers at Industry Conferences

In prior posts, we have gone over what happens at industry conferences.  The process of allocating meetings to investors such as mutual funds, hedge funds, pension plans, etc. was reviewed.  There is another client at the meeting - the corporate representative.  This can be a high level manager at the company such as the CEO, Chairman, President or CFO or the Vice President of Investor Relations.  The investment bank asks the buy side who they want to meet.  During the scheduling portion of the conference set-up, this list is previewed by the corporate.  At this time, the corporate may edit the list.  This could be as follows:

1. I want to see these 3 investors because they are long term holders of my company
2. I do not want to see this investor because they are traders of my stock
3. I need to see this investor because they hold 5% of my company

The corporate access team at the investment banks are always balancing the needs of the buy side with the needs of the corporates.  They have to handle 2 different sets of customers.