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Shifting Prime Relationships Burden Smaller Funds
Hedge funds adjusting to the new prime broker
March 2, 2009
It's a difficult time to be a small hedge fund. Many funds that manage less than $300 million have reportedly been shown the door by their prime brokerages, and others, even if they've generated positive returns, are now being charged for technology development and other services that once were free.
On the other hand, falling revenues may also be prompting prime brokers to deliver their services more efficiently.
Last year, Wall Street's most storied brokerage firms either became commercial banking companies or were acquired by one, effectively ending the era of high leverage. Providing leverage, however, has been the prime brokers' main source of revenue. As lending tightened, bulge-bracket firms began reassessing the size and business priorities of their prime brokerage units and analyzing the profitability of their clients--and deciding what level of service to provide them.
When Nemesis Inflation Preservation Fund's assets fell from a high of $150 million to less than $100 million, Goldman Sachs said the fund could no longer be maintained on its prime brokerage platform, according to Mohammad Ahmad, COO and chief risk officer of Global Macro Investments (GMI), which acts as Nemesis' adviser. Ahmad noted that the fund, which started up in January 2008, saw its assets drop because the company seeding it pursued massive redemptions later in the year. "But in terms of performance, it's up 3 percent to 4 percent from last year," Ahmad said.
Now, Nemesis uses Newedge, formed last year by the merger of the brokerage arms of Crédit Agricole and Société Générale. Smaller funds that lose access to one of the premiere primes must turn to an introducing broker-dealer that clears through someone else or a self-clearing firm like Newedge.
Zug, Switzerland-based GMI's own Bernina Fund, which started at $5 million and is now at $17 million, has seen a 17 percent return since its April launch, he said. Despite its size, Goldman is still providing Bernina with prime brokerage services. "Its global-macro strategy is in vogue now and it's a potential allocation target for their clients," explained Ahmad.
Nevertheless, Goldman is no longer as generous with its services. The firm introduced GMI to Imagine Software, a New York-based company whose risk management tools provide on-the-fly scenario analyses and assist in monitoring and developing investment strategies. Goldman, said Ahmad, continues to provide access to technology such as its RediPlus execution management system; margin and collateral reports for products including over-the-counter instruments; and portfolio-level analysis that helps the fund understand how the prime broker views its risks against various market scenarios.
However, Goldman now wants customers to shoulder some of the operational costs. "We have Imagine in-house, so Goldman will say that to develop a new interface for FX transactions, you'll have to either cover the development costs or pay a ticket fee," Ahmad said.
Previously, such costs were assumed by Goldman, which generated revenue by providing financing, he noted. Now it's $8 per ticket, and Goldman is charging Bernina a flat fee of $40,000 a month. "It's quite an expense for a small fund," Ahmad said, citing additional fees for services like fund administration. "We have a fixed-cost basis of $70,000 to $75,000 a month just to stand still."
But Goldman is one of a shrinking pool of custodians that investors still favor. In fact, GMI may be fortunate to claim Goldman as its provider at all, since the biggest primes are weeding out clients that do not pass revenue minimums or show little prospect for growth.