Prime brokers to score more order flow from hedge funds

Prime brokerage revenues are expected to increase 15% over 2006, and to outpace traditional institutional business over the next two years, according to a report by Tabb Group, a capital markets research and advisory firm.

The report finds a correlation between which banks hedge fund choose for their prime brokerage business and the ones they choose for their cash equity business.

The report said: “Hedge funds route more order flow to the cash equity desks on a percentage basis than the core broker of a traditional asset manager… More than 80% of hedge fund participants said that at least 10% of their equity order flow is sent to each of their prime brokers' cash equity desks."

The cash equity desks of the major prime brokers receive more than $3bn in equity commissions per year, according to the report.

Financing rates and capital introductions are among the top priorities that influence a hedge fund manager’s choice of prime broker, according to the report. Large hedge funds with over $3bn in assets under management spent an average of $6.3m for prime brokerage services, almost three times what small- and medium-sized hedge funds paid.

Hedge funds have an average of three prime brokers for the purpose of comparing fees and service levels.

Yet large funds have reduced the number of prime brokers they use from 4.8 two years ago to 3.7 expected this year. Small hedge funds have increased the average number of prime brokers used from 1.3 in 2006 to 1.7 this year, according to the report.

Historically, small hedge funds have only used one prime broker, but the near collapse of Bear Stearns has led more hedge funds to add prime brokers to limit counterparty risk.

The report interviewed 61 US based hedge funds, 49% with assets over $1bn.

The average size of hedge funds has increased 143% since 2006 to $4.5m, according to the report.