Brokers seen riding hedge fund wave
By Chris Sanders
NEW YORK (Reuters) - Wall Street brokerages expect to see a larger portion of profits from servicing the growing hedge fund industry, but not without some bumps along the way, industry executives said.
As public pension funds, endowments and other large institutions pour money into these funds, major U.S. banks and brokers are ramping up their prime brokerage units that service the politely labeled "alternative investments" business.
"Prime brokerage is now the next thing they (Wall Street) are chasing," said Brad Hintz, a senior banking analyst with Bernstein Research said at the Reuters Finance Summit.
Morgan Stanley, Goldman Sachs Group and Bear Stearns Cos. already service about three-quarters of the sometimes risky but potentially lucrative investments, raising the barrier of entry to newcomers.
But rivals such as UBS AG Lehman Brothers Holdings, Merrill Lynch & Co. and Citigroup Inc. are building their own prime brokerages in pursuit of hedge fund cash, experts said.
Currently the super wealthy make up two-thirds of investors in hedge funds with institutions filling out the other third.
Charles Gradante, a managing principal at Hennessee Group hedge fund advisory firm, said institutions in the next few years will likely become the source of the majority of hedge fund cash.
In the last four years, the hedge fund industry has doubled in size to $890 billion as more investors wanted to erase the bear market's heavy losses.
Calpers, the No. 1 U.S. public pension fund with $166 billion, said it may soon add $1 billion to hedge funds, doubling the investment it began making in the hugely popular funds two years ago.
Other state and local pension funds have been increasing hedge fund investments in recent years as well.
Prime brokers offers hedge fund managers a range of services from clearing their trades, securing financing and introducing them to wealthy clients. Sometimes prime brokers even find them office space with computers, software and other technology already set up and ready for immediate trading.
Yet industry growth, especially among funds that invest in equities, may hit a few speed bumps ahead.
Gradante said the securities lending portion of the business could run into a shortage of shares to borrow. In securities lending, middlemen such as brokerage firms borrow stock from asset managers or other large holders of desired shares needed to sell short a stock.
"I don't think the (equity hedge fund) industry the can grow beyond $2 trillion (in assets)," Gradante said, citing hampered securities lending as one significant drag on growth.
Some small cap and thinly traded stocks have already become difficult to borrow as demand has risen, he said.
Moreover, fierce competition among brokerages to snare hedge fund clients will lead to increased price competition and lower profits.
But Vikram Pandit, President and Chief Operating Officer of Morgan Stanley's Institutional Securities division said his top-ranked prime brokerage is used to the competition.
"Don't for a minute believe the market has been any less competitive in the last five years," Pandit said at the Summit held at Reuters offices in New York.
James Ellman, with the San Francisco investment firm Seacliff Capital, said bigger hedge funds already use more than one prime brokerage to service their needs.
Going forward, as funds grow, they will increase their use of multiple brokers, forcing more competition on fees and cutting into brokerage profit margins.
"The only way you can compete is on price," said Bernstein's Hintz. |
