By Suchita Nayar
Given JPMorgan’s strength during the financial crisis of 2008, the bank was one of the beneficiaries of the shakeout among prime brokers, especially with its purchase of Bear Stearns, one of the top players for decades. But JPMorgan’s success has been aided by its embrace of the technology that actually helps hedge funds spread their business around.
The collapse of Lehman Brothers, which many hedge funds used as a prime broker, was the biggest impetus to accelerated use of more than one prime. “The events of 2008 have jolted both hedge funds and their investors,” says Jon Firester, chief operations officer at JPMorgan’s prime brokerage unit. Post-crisis, hedge funds began to hire more than one prime broker, both to keep their investors happy and to use as an internal risk management tool.
But without the technology to help it, the industry’s multiprime push would have sputtered along. In a single-prime scenario, the manager-broker data exchange is relatively simple: There’s a single focal point of all processes associated with the minutiae of a manager’s daily activity encompassing, trades, collateral, margins and the like.
Imagine the same setup across a variety of primes, and the amount of information coming at the manager explodes. Absent the technology to simplify the aggregation, the manager would require a high degree of personnel sophistication to properly coalesce and analyze the raft of information, raising costs.
“Excel spreadsheets don’t cut it anymore. The manager must be able to explain each piece of data, how it got there, whether it is correct,” says Stuart Plane, a director at Cadis Software, a London data management company.
Larger hedge funds have built or acquired the technology to meld together data feeds from the various primes and then use this merged information to run complicated risk analytics, calculate net asset values and so on. But some funds with less than $1 billion under management are looking to their prime brokers to provide these systems as part of a bundled offering. In this scenario, each fund would typically install one institution as its primary prime broker, which by default also becomes the provider of this data management technology.
To help its clients, JPMorgan collaborated with Sophis, a portfolio and risk management systems specialist, to develop the iSophis risk and performance management tool. Once iSophis is connected with all of a fund’s primes, it captures trade and position data and consolidates it for the manager at the end of each trading day. “The next morning, you can look at your aggregated P&L, risk reports and performance,” says Firester. The software tool could also be used to deliver the data to the fund’s third-party administrator.
Eric Bernstein, chief operations officer of Sophis, says there’s ample room for customization with the system. At a basic level, there’s the need to harmonize the way each prime classifies stocks. For example, a manager buys shares of IBM using two prime brokers. Each prime has a unique way to classify the stock, which means the shares could get tagged as “IBM.N-large cap” by one and “IBM.US-hardware” by the other. The manager, meanwhile, would want both IBM positions aggregated and cataloged perhaps a third way. So, the system has to be mapped to merge different feeds from primes as per the manager’s specifications, says Bernstein.
Managers can customize the information they see on their screens, and its layout. Also, the system can be tailored to run tests on how certain market moves would affect a portfolio.
Credit Suisse’s prime brokerage clients get access to the technology of Paladyne Systems of New York, whose fully hosted IT platform sells front-to-back-office services to hedge funds.
The bank, which is credited for taking an early start in embracing multiprime, says the biggest operational leap is when a manager jumps from a single to two primes. “It’s like a root canal. It isn’t something you want to do, but at some point, it’s a necessity,” says Paladyne chief Sameer Shalaby.
Moving beyond two primes is not as difficult as taking the first step, but it is costly. The added expenses are not just for the software component but also for operations support, third-party licenses, market data and additional hardware. Historically, only the multibillion-dollar funds could afford it. For a smaller one, the primary prime usually picks up most of incremental tab, making multiprime more palatable to the subbillion-dollar hedge funds. “A counterparty that doesn’t have this capability will find itself losing business to those who have it. The ‘use me as your single prime’ argument won’t fly anymore,” Shalaby says.
Some have gone the independent vendor route. Lighthouse Investment Partners, a $5 billion fund of funds in Palm Beach Gardens, Fla., has codesigned a proprietary portfolio management system along with Fascet, a data management vendor. In an unusual tack, its technology captures daily trade flow from each of its underlying managers and its respective counterparties. Then, in a step called “normalization,” the system rejigs the data across asset classes, including over-the-counter derivatives.
This methodology holds Lighthouse’s underlying managers and theircounterparties in its grip, and gives Lighthouse a front-row view of all of their investment actions and real-time valuations. Moreover, the point of having the software in place is also to drive the data’s accuracy, timeliness and completeness, according to Lighthouse.
Pulling together a complex web of data requires careful mapping out of the workflow and thoughtful front-to-back-office processing and coordination across a myriad of trade execution practices and order management systems employed by underlying funds. It’s “an integral part of our business model,” says Kelly Perkins, co-CIO at Lighthouse.
Additionally, Advent Software’s Geneva software has a strong standing among managers for all of their portfolio management reporting needs. Prime brokers and administrators use it, too. Geneva pulls in cash, position, transaction, and exposure data from different counter-parties, and often in varying formats, into its unified and consistent reporting platform.
“Clients tell us that prior to using us, they maintained and reported data manually and each one struggled to be accurate,” says Christopher Momsen, senior vice president of sales. Now they use Geneva to address the complexities of a global marketplace or to maintain transaction granularity across all asset classes. “They use it to slice and dice data any way they want,” he adds.
Multi-prime also requires funds to develop internal best practices for robust reconciliation and error elimination. “When done properly, moving to multi-prime would arm you with information to mitigate your investment and accounting risks,” says Momsen.
Setting up multiprime arrangements is especially difficult for new funds, and getting the right technology is what makes it doable, according to Pimco alumnus John Brynjolfsson, who established his global macro fund Armored Wolf, of Aliso Viejo, Calif., in early 2009 and surpassed the critical $100 million-asset threshold in January.
Brynjolfsson knew that investors needed assurance that in the event of a crisis, Armored Wolf would seamlessly redirect its business to another prime. For the fledgling business, it was a tough choice, though. He knew that economies of scale are lowered by spreading the wallet across primes and that there would be duplication of effort in setting up multiple credit lines.
Moreover, leverage availability could decline with cross-margining in a multiprime arrangement. (When one prime broker holds all of the collateral and trades, it can extend more credit.)
And finally, primes had to have twice as much confidence in the fund’s long-term viability and growth targets in order to settle for half the assets and trading volume.
But Brynjolfsson says that by using the right technology offered by Bloomberg and fund administrator GlobeOp, the challenges were met. “For start-ups with deep pockets and a substantial commitment to infrastructure, hurdles to multiprime can be overcome,” he says.
