Hedge Fund / Prime Broker Relationship Set for an Interesting 2024
1/9/2024
According to Nasdaq eVestment, in 2023, investors pulled a total of $75bn from hedge funds through the end of November. And, according to HFR, the average hedge fund returned just +4.82% year-to-date through the end of November. In comparison, the S&P 500 returned approximately 24%.
Despite the overall redemptions, the back end of the year tends to be heavy in new Form D filings for hedge funds as the fund managers look to begin raising capital and trading at the start of the new year.
Time will tell whether a more stable macroeconomic and geopolitical climate will help or hinder hedge fund performance – and in turn, asset flows - this year, but one thing we’re interested to see is if and how the hedge fund / prime broker market will change this year.
A few developments could impact the space. The switch to T+1 settlement in the US will be flipped in May, which could lead to something of a shake-out in PB hedge fund customer rosters. Manual trade reconciliation processes, which worked fine in a T+2 regime, won’t in a T+1 world. and so hedge funds that don’t get their middle and back-office up-to-speed to help their PBs, may find themselves looking for a new prime. Additionally, the SEC has put the onus for compliance on the sell side, so a prime won’t hesitate to move on from a client that it thinks poses a potential risk.
But where one side of the hedge fund/PB coin sees the primes concerned about their hedge fund clients, the other side sees hedge funds concerned about the primes. An interesting report published by Acuiti at the end of October last year says that smaller hedge fund firms are concerned about consolidation in the FX prime brokerage market, with 43% of survey respondents saying that they were either quite or very unsatisfied with their FX PB options.
Emerging hedge funds already face an uphill battle in terms of building a sustainable business. The regulatory environment continues to get ever more burdensome, and it’s generally understood that assets continue to flow to the larger managers and funds more generally, making asset raising more difficult over time. Now, they face additional hurdles with their PB relationships.
The optimist, however, will say that all this creates opportunity for ‘challenger’ brands in the PB space. Some PBs with a lower risk appetite will likely be more aggressive in shedding clients, with others waiting in the wings to add these hedge fund firms to their client list. It also wouldn’t be a surprise to see more M&A in the space this year, consolidating the middle of the pack (in terms of size). Smaller hedge funds that still trade frequently will be coveted by challenger PBs, and this article that discusses the merits of a high-touch customer service offering by PBs may be a factor into which of the primes either moves up or cements its place in the upper end of the mid-tier bracket.
2024 is set to be as interesting a year as we’ve seen in a while for the hedge fund/prime broker market.