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Shifting Prime Relationships Burden Smaller Funds
March 2, 2009
Prime broker relationships have been smoother for many of the bigger hedge funds. According to Adam Stern, chief executive of AM Investment Partners in New York, his firm has yet to see any service changes. AM Investment's assets under management peaked last summer at just over $1 billion. Last week, said Stern, that number was closer to $800 million--still respectable, given how far the markets have fallen.
AM Investment in 2001 introduced its first fund, a convertible strategy that has suffered in the recent downturn, said Stern. The firm also manages merger arbitrage and volatility funds, the latter of which provided positive returns last year.
Although Stern declined to name his firm's prime brokerages, he noted that "we want to have a solid U.S. bank, a European bank and a solid brokerage such as a Morgan Stanley or Goldman Sachs." He added that peers have received difficult phone calls from their primes saying rates or margin requirements are increasing.
Part of the reason that AM Investment's services have not been altered, said Stern, may be its relatively low use of leverage. That practice is likely attractive to prime brokers, who are seeking to remove leverage from their balance sheets. And, of course, the fund company's assets place it among the sizable funds that top primes are most eager to do business with.
Stern praised the quality of his primes' risk-related reports, which his firm compares to those provided by its fund administrator, GlobeOp Financial Services, and the risk analyses it generates with third-party software--AM Investment also uses Imagine Software.
One change that Stern has seen is the way that banks his firm deals with view their prime brokerage unit. Previously, the prime, cash-equity, over-the-counter derivatives, futures and other desks operated separately from one another. As a result, the OTC derivatives desk might have denied services to a hedge fund starting out in that market with low volumes, even though the same fund was a major customer of the futures desk.
That approach continued through the second half of last year but has more recently turned around. "I see increasing cooperation across desks," Stern said. "Whereas before people were focused on their own business, now they're saying, 'Let's look at this fund's business holistically,' and prime brokerage is just one of the pieces to look at."
Stern said his firm is very active with the options desk of a major financial firm, which he approached last summer to propose using as a prime broker. The brokerage responded that Stern's firm didn't use enough leverage to open the account. Then, in late December, when "the dust had settled" after three months of volatility, said Stern, the broker came back to AM Investment and asked about its other business opportunities, in an effort to consider the hedge fund's overall relationship.
"They're not going to make prime brokerage a loss leader for their other businesses," said Stern. "But if the firm had a profitability hurdle to pass if we were only a prime brokerage client, then they would probably give us a bit of a discount if we were profitable in other parts of the firm."
That change is significant, said Stern, considering the competition for profits that had existed between a large broker's various desks. It is also a more effective way to draw business at a time when belts are being tightened. And with hedge funds' increasing adoption of multi-prime strategies, capturing a fund's other types of business has become even more important. AM Investment not only has several primes, but two for each account. "After a year like last year," observed Stern, "you have to continuously assess your counterparties, and you may have to make dramatic decisions to move balances to protect investors' assets."