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Investment Banks Continue to Dominate Hedge Fund Prime Brokerage Market Share – May 2014

by Jesse Fahy

  • 28 May 2014
  • HF

Preqin’s Hedge Fund Analyst online service currently tracks 142 prime brokerage firms which service a combined 5,222 hedge funds. Many of these hedge funds rely on the largest prime brokers in the industry to service their funds. In fact, the six largest prime brokerage firms by market share (Goldman Sachs, Morgan Stanley Prime Brokerage, J.P. Morgan, Credit Suisse Prime Fund Services, UBS Prime Services and Deutsche Bank Global Prime Finance) account for just over 70% of the total coverage for the industry.

In comparison, 24% of CTAs tracked by Preqin list Newedge Prime Brokerage Group as their prime broker, but no other prime brokerage firm represents more than 8% of the CTA industry. Eight different firms service between 5% and 8% of the represented CTAs, these are mostly large investment banks, although Interactive Brokers, an online discount brokerage firm, breaks the stronghold of investment banks. Together Newedge and Interactive Brokers represent nearly 30% of the market share for CTAs, demonstrating a market for prime brokers who cater specifically to the needs of CTAs. 

Continuing on the idea of fund size in relation to fund prime broker, one of the clearest examples of this relationship is in the number of prime brokers employed by a fund. Using multiple prime brokers diversifies the fund’s counterparty risk, but also subjects it to increased cost. For this reason, we see a trend where the larger funds tend to employ more prime brokers, while the smaller funds tend to stick with only one or two prime brokers. In total, 55% of hedge funds tracked by Preqin employ a single prime broker, with these funds having average assets under management of $198mn. Twenty-six percent of funds tracked use two prime brokers, 11% use three prime brokers and the remaining 8% use four or more prime brokers. Unsurprisingly, on average these funds are all larger than the funds that use a single prime broker, averaging $388mn, $887mn and $1798mn in assets under management respectively. 

In the Preqin Special Report: Hedge Fund Service Providers, over 100 hedge fund managers were surveyed on whether or not they had changed prime brokers in the past 12 months and why. The results of this survey showed that 53% of managers surveyed had changed prime brokers in the last 12 months, narrowly trailing fund administrators as the highest service provider turnover. The top three reasons for switching service providers, in order, were: cost, dissatisfaction at quality of service and growth in firm assets under management. These results reflect the weight that fund managers put on choosing a service provider, and the high turnover points to a volatile industry in terms of market share. 

Choosing the right prime broker is essential to ensure that the trades entered by a fund are executed efficiently and along with the other service providers it enables the fund to operate at its peak abilities. The importance of the prime broker is evident in the turnover and in depth selection process that occurs within the hedge fund industry. As we enter the second half of 2014, we will look to see if the major investment banks continue to dominate the industry, or if more specialized prime brokers emerge.

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