Say this for Bernie Madoff: He has been a one-man stimulus package for so-called midtier prime brokers. “After Madoff, hedge funds wanted to demonstrate that they used third parties and were not self-administering,” explains Ronald Fertig, COO of Greenwich, Connecticut–based hedge fund Centaur Performance Group. Of course, he adds, a lot of funds also opted for more than one broker after Lehman Brothers “crashed and burned.”
Hedge funds have, in fact, begun hiring several prime brokers, giving a leg up to midtier players — chiefly BTIG, Jefferies & Co. and Merlin Securities — in their rivalry with such giants as Bank of America Merrill Lynch, Credit Suisse and Goldman, Sachs & Co.
Smaller hedge funds’ impetus to turn to midtier brokers also apparently stems from their feeling neglected. As large banks cut staff, they stationed fewer, and newer, faces on customer desks. By contrast, midtier prime brokers, which have built multiproduct, multiasset platforms, can mimic the product offerings of bigger firms while also giving customers more attention. “Those $500 million to $1 billion hedge funds are not important to the really big [prime] players,” says Matthew Simon, an analyst at London- and New York-based capital markets research firm TABB Group. “So we’ve seen the rise of midtier primes.”
The big prime brokers, not surprisingly, have a different take on things. “It’s a difficult landscape,” says Steven Keller, head of prime brokerage sales at BofA Merrill in New York. “Without the full breadth of product, it’s not easy to compete.” Nevertheless, Keller concedes, “some clients are better suited to smaller providers, though as clients become more successful and their assets ramp up, they often graduate to larger prime platforms.”
Sheldon Rubin, COO of New York long-short firm S Squared Technology, describes his own company’s arrangement with Jefferies in glowing terms: “We have a relationship with key people. It’s not too huge an operation, so it doesn’t provide inordinate attention to the biggest clients only.” He praises the knowledgeable people in securities operations. “They can cover our shorts,” Rubin says.
What defines these upstart midtier prime brokers? The firms squabble over which ones qualify. Glen Dailey, chief of prime brokerage at Jefferies, insists his firm is the only full-service midtier prime broker. Merlin Securities is too small, say some, but Ronald Suber, head of global sales and marketing, contends that it deserves the label because it performs the key functions of execution, reporting, research and securities financing.
Perhaps the smartest perspective belongs to Denise Valentine, a senior analyst at Boston research firm Aite Group, who wrote a report on smaller prime brokers in February. “Divisions are not relevant,” she says. “Does the entity provide prime services to a fund that has to go to primes for financing and custody? Any firm that does its own financing and own clearing is a prime.”
Certainly, Fidelity Investments qualifies as a prime broker, although it objects to being assigned a midtier ranking. “The way I look at it,” says the head of Fidelity’s prime services unit, Thomas Tesauro, “a firm either clears for itself or it doesn’t, and that’s the demarcation. We’re a full-service broker.”
Hedge funds began seeking out Fidelity for its prime brokerage services after the crash. “They wanted a safe place to come to,” says Tesauro. The firm offers client service, financing and, notably, securities lending for shorting purposes. “We have a huge supply of equities — $1.2 trillion in assets,” he notes.
Using multiple brokers diversifies risk, but funds can also be played off against one another to tamp down fees. Yet there’s one annoying downside to employing lots of brokers. Says S Squared’s Rubin, “Trying to integrate all the information from all these primes can be horrendous.”
