Paladyne Sees Tighter Relationship Between Hedgies And Their Primes

Aug 2 2007 | 12:10pm ET

There’s a shift underway in the relationship between hedge funds and their prime brokers toward a new partnership model, where both sides adapt their business models to the increasing growth in the hedge fund industry.

In a paper titled, "The Next Generation Multi Prime Broker," Paladyne Systems said prime brokers are realizing they have to adapt their business models if they want to sustain the high level of profitability their parent investment banks have grown accustomed to in recent years. In order for tomorrow’s prime broker to be successful and to capture more assets in a multi-prime world, Paladyne identified a new prime broker business model with five requirements including broker-neutral technology; independently-hosted technology; middle- and back-office services; fund administration and independent net asset valuation; and independent business consulting services.

“There used to be two or three primes that dominated the industry but now we’re seeing much more competitive pressure on the brokers because there are now big banks getting into that market,” Sameer Shalaby, CEO of Paladyne Systems, told FINalternatives. “This is forcing prime brokers to come up with new ways to service these clients. The new ideas are expansion of their service and bundling their pricing with a number of things. This is what led us to what we’re determining as the next generation of prime brokers.”

However, as cost pressures and infrastructure demands intensify, more and more managers are choosing to maintain multiple prime broker relationships to get best access, competitive pricing, and, to a lesser extent, non-traditional services such as middle-office support, fund administration, and comprehensive technology.

Smaller hedge funds are adding second and third prime brokers for better service and competitive pricing while larger firms in the multi-billion range that are currently employing five or more prime brokers are finding it difficult to manage their operations dealing with so many counterparts, according to Shalaby. 

“So we’re seeing an industry average settling around three prime brokers,” he said.  

Going forward, Shalaby expects the hedge fund industry to be regulated in some fashion forcing smaller hedge funds to invest in their technology and operational infrastructure.

“A lot of hedge funds run their businesses on spread sheets and if you’re going to be managing $500 million and up you really need better operational infrastructure, technology, staff and compliance,” he said.

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