What Is a Hedge Fund Broker?
- The term hedge fund stems from the strategy of investing in a position and hedging your bet in case your position is wrong. Hedge funds use high-risk strategies and place bets on both long and short sides in order to gain absolute returns. This means that hedge funds seek to make the same return regardless of market conditions. A prime broker acts as the hedge fund's central broker who executes trades for the fund, usually online or through an automated computer system. Moreover, a prime broker can facilitate trades in large blocks or in illiquid securities.
- One of the main advantages of using a prime broker is that he (or she) will act as a custodian to all of the hedge fund's financial assets. Thus, no matter who actually executes a trade, the assets are settled and then transferred back into the account with the prime broker. This simplifies reporting and managing a fund's portfolio. On top of that, by keeping all of the assets in a single account, the hedge fund then can use all of its assets as leverage for margin purposes.
- Aside from trading and custodial services, primer brokers offer hedge funds a lot of other benefits. Prime brokers provide hedge funds with leverage and margin (ability to borrow cash), as well as security lending for short sales. Brokers help funds raise capital by introducing potential investors to the funds. Brokers also have access to initial public offerings (IPO) and can sell the IPO stock to the hedge fund. In addition, a prime broker will often provide IT support, lease office space, give advice and create reports for hedge funds.
- Prime brokers normally do not charge a fee for the entire package of services they provide, but instead make money through trading commissions and fees on transactions. Most of the money earned by brokers comes from the spreads on loans to their clients. Thus clients who take on a lot of debt, or trade short, are much more lucrative to brokers than clients who maintain a credit balance and mostly trade long.
- A prime broker can make the difference between a successful and an unsuccessful hedge fund. Fund managers often take months before deciding on a brokerage firm to use for their business. They evaluate firms on their ability to provide all the services needed as well as maintaining the motivation to help. It is important to choose a firm that values you as a client in order to get the most out of the brokerage.