The relationship between hedge fund and service provider has been under increasing scrutiny in recent years as both parties look to squeeze the other for savings and revenue. Having previously analysed internal costs, this report’s third section explores the external factors impacting hedge fund business margins. From service provider relationships to technological disruption, we look at the key outside expenses as well as the techniques managers are using to run more efficiently.
Cost management is a topic of the utmost importance to hedge fund managers of all sizes. As one fund manager interviewed by HFM Insights told us “we’re constantly reviewing it. We had a budget meeting last week – where can we cut costs? Everyone is looking at expenses.” In this section we will examine the internal costs firms can alter and how they might do so in order to streamline their businesses and maintain competitiveness.
Building a sustainable hedge fund business is as challenging now as it has ever been. Not only are managers faced with a host of new cost burdens – many regulatory and technological in nature – but the environment in which they operate is particularly unforgiving. As one business consultant HFM Insights interviewed said, “cost management is a huge issue for funds of all sizes. The question is what are you doing and what happens when you run into problems? Do you just shut down?”
Throughout our interviews with hedge fund professionals, one observation in particular was often repeated: the relationship between prime broker and client has become increasingly “business-like”. Certainly, the drivers behind the recent increases in fees – the result of external factors rather than internal policy – have given primes reason to be hard-headed, and managers have responded in similar fashion. But although the prime brokerage environment may resemble a meritocracy, it does not mean that primes are being selected, dropped and/or saved based purely on quality of service.
In the years before the crisis, no-one talked about prime brokerage ‘revenue hurdles’ because there wasn’t any need. Managers were generating good numbers, primes had clients who were profitable already or going to be, and the only time the topic came close to being discussed was when a manager failed to make the cut for an exclusive cap intro event. Now, amidst a period of truncated margins and fierce competition, it is not just the elephant in the room, but part of the conversation.
Amidst global economic turmoil, regulatory upheaval and increasing competition, the relationship between hedge fund manager and prime broker has become as much a source of tension as it has one of revenue. Prime brokers are being squeezed by rising operational costs and a reduced ability to lend, with hedge funds feeling the after-effects. As a result, the context in which these tensions have developed is an important ingredient in any remedy for the ills in the relationship, and is the natural starting point for this report.