In order to understand what hedge funds do, you need to be pretty well familiar with the large investment teams that are the entry point to the global market. The name for this banking team is prime brokers. Having an online brokerage account and participating every now and then is not going to get you in the game of trading securities with the top dog hedge fund prime brokers. These prime brokers are crucial to the success of a hedge fund, particularly if you want to sell short to magnify a bet by borrowing money.
What does a hedge fund prime broker do?
Well, a prime broker will provide execution services as well as custody service. In addition to that, a good prime broker gives out hedge funds with the added possibility of securities lending which is borrowing stocks and bonds. You can also go through a hedge fund prime broker in order to borrow the money that you need to buy stock and bonds or margin financing capabilities. Whatever prime broker you use will act as a mediator between the hedge funds and the other two counter parties like pension funds or institutional investors.
Hedge fund prime brokers are usually very closely involved with short selling as well. This is when a security is sold short. When an investor bets that the price of security is going to fall, it is known as short selling.
What is the difference between borrowing cash and borrowing securities?
Where hedge funds are concerned, this is a pretty significant different. Lending cash is a commodity service and lending securities is not. Any kind of lending usually requires some sort of collateral to be offered up. Prime brokerage is no different in that realm. However, securities lending is when a stock or other security is loaned to a firm or an investor. A letter of credit, cash or another security can be put up as collateral. Lending cash on the other hand, is more like a regular personal loan.
How do you select the right prime broker?
This is a very important choice for a hedge fund manager. There are several things that you have to keep in mind when looking into prime broker services. It doesn’t matter if you have a start up company or a fully functioning multi billion dollar fund that is closed to further investments, the considerations are the same. They are as follows:
- Price – how much is the broker going to charge you?
- Access – how much access does the broker have to securities that are hard to borrow? Also, do they have access to term lending and IPO information?
- Worthiness – are they credit worthy?
In order to look into hiring a prime broker, understanding the fund manager, management structure, management operations as well as the investment process that needs to be followed. A prime broker’s idea of risk is going to be pretty different from an investor’s view so you need to make sure that the prime broker you are looking into is going to protect you in the way that you think you should be protected.
The prime broker that you choose is going to affect the way that investors see you. If you are working with a reputable and well known broker then this can really help you when it comes to communicating with investors. If your fund is only a start up at the moment then a respected prime broker will help to establish your credibility in the industry. Your choice also has a lot to do with the efficiency of your operation. Furthermore, choosing the right prime broker will give you the right services for your needs. The services that each prime broker offers will play a huge part in how you manage your expenses which will affect the types of things that you invest it or borrow against. Your administrator and your prime broker will have to work together in order to make each of their data as accurate as possible.
Be careful when choosing your prime broker. Your long term viability is the hands of the individual or the firm that you choose to be your prime broker.