New prime brokerages with deep pockets now have a better chance to pirate business from the big boys or get more business from existing clients.
That’s what officials of Fidelity Investments’ prime brokerage unit are hoping as they expand the scope of their service. So they will start providing executions of European stocks beginning this summer.
"Clients have been asking us to do this and now we’re ready to offer it with select clients starting in July," according to Thomas Tesauro, executive vice president of Prime Services at Fidelity Capital Markets.
The Fidelity prime brokerage unit had previously been restricted to long and short U.S. equities. But that put some clients at a disadvantage.
"Many times we were one of a number of primes, but they could only give us a percentage of their portfolios; they couldn’t give us more because we could only do their U.S. business," he added. The expansion will include international custody, clearing and trading services, Fidelity officials said.
Fidelity’s little known prime brokerage unit has some 105 hedge fund clients. The average fund holds roughly $1 billion in assets under management, the firm said. That puts Fidelity in the middle of the pack of prime brokerage providers, according to industry observers.
Tesauro hopes that the European option will improve Fidelity’s presence in the prime brokerage market. Until recently, Fidelity was little regarded as a serious prime brokerage player. Even two years ago, a company spokesman said the firm hadn’t been communicating its message publicly.
Indeed, the prime brokerage unit, which is actually six years old, was hardly known by most hedge fund managers until about a year ago. That’s when Fidelity officials thought that problems in the marketplace could actually benefit relative newcomers to the prime brokerage business and they started making a new push.
Fidelity, still not one of the heavyweights of prime brokerage, said the market meltdown of 2008 provided an opening for them. The failures of Lehman Brothers and Bear Stearns have changed the outlook of some hedge funds, Fidelity officials said.
"Fidelity’s strategy can work," said Denise Valentine, a senior analyst with Aite Group. She added that many hedge funds are still worried about having the assets frozen if another market meltdown happens.
Consequently, hedge funds are now more likely to have more than one prime brokerage relationship than before the market turmoil, one market observer said in a recent report.
"Medium-sized hedge funds will gravitate toward a pairing of a bulge bracket broker and a secondary player," the TABB Group wrote in its latest annual survey of prime brokerage.
"This enables them to diversify counterparty risk while maintaining meaningful account balances at two firms," according to TABB’s "U.S. Prime Brokerage 2009: The Hedge Fund Perspective."
For the survey, the TABB Group interviewed 62 U.S.-based hedge funds with assets under management averaging between $500 million and $3 billion.
The downside of multiple primes is that a fund must pay more than it would with a single provider. In addition, potential operational problems can increase.
Valentine said Fidelity and others aiming for secondary prime relationships will offer services that will ease the potential operational problems of having two or three prime brokers.
Still, the reason for a secondary prime is to reduce the risk of frozen client assets should one prime fail. That happened to numerous hedge fund clients whose assets were tied up when Lehman Brothers and Bear Stearns collapsed.
Fidelity officials also argued that they have a stable, non-conflicted offering, noting this will entice mid- to large-size hedge funds looking for another prime or a secondary relationship.
"We don’t do distressed securities and we only do agency trading, so we are not competing with our clients," Tesauro said. Fidelity officials also underscore that their parent, a giant fund company with huge assets, has deep pockets.
Tesauro conceded that "the crisis allowed us to get in the door with the clients." But he added that offering European equities alongside the unit’s emphasis on its financial stability will lead either to a greater percentage of a fund’s business or new relationships altogether.
Fidelity’s target? The biggest prime brokers in the business are JPMorgan, Goldman Sachs and Morgan Stanley, according to recent numbers by Hedge Fund Research. Would clients of these prime brokerage heavyweights consider defecting or dividing their business among several prime brokers?
Some 12 percent of funds recent surveyed by TABB Group said they were looking for another prime broker. And another 39 percent of the same group said they will consider an additional prime broker if assets under management grow.
But what Fidelity didn’t discuss is how some fund officials are still spooked by the Lehman-Bear Stearns blowups. Indeed, TABB Group reported that bank failure concerns have led to a 20-percent increase in prime relationships.
"Hedge fund participants," TABB Group wrote, "say that the events that occurred within the industry have led them to believe that bank failure is real and counterparty risk needs to be reduced."
