More than 350 people attended Morgan Stanley's recent Asian Investment Conference in Shanghai, spread across 58 managers and 120 investor groups. We spoke to two of the most senior prime brokers in the house: global head of prime brokerage Alex Ehrlich, and head of US prime brokerage Ed Keller, both based in New York.
If markets start heading further back down from here towards 2009 lows, would hedge funds make more money from that occurrence this time?
Alex Ehrlich: You can't generalise, as there are many different hedge-fund strategies. The industry today though is more concentrated around equities than it had been pre-crisis, also risk and leverage levels are more conservative than before. If 2009 lows are hit again this year, I'd expect overall hedge-fund performance to be negative, because few are expecting that kind of market collapse, but relatively, hedge funds should still outperform the market.
Ed Keller: You talk about what happened last time. No way will it happen exactly the same twice in a row. For example, the prime brokerage industry doesn't provide leverage on illiquid assets like it once did, because in a crisis, one can't fund it.
What is Morgan Stanley prime broking doing differently now than in 2008?
Ehrlich: The terms on which the prime-broking business provides 'balance sheet' and liquidity for its clients - for example, loan tenors, and terms for financing collateral - is now wholly integrated with our firm's treasury management process. They give us a defined pool of liquidity, and that pool is managed and allocated by our prime- brokerage business. Every prime-brokerage obligation is known to and integrated with the treasury group that manages the entire firm's balance sheet
If the proposed Volcker Rule is passed, will that affect a prime broker's operations and business?
Ehrlich: No, we see no direct adverse impact for our business. However, if the rule were to result in the disgorgement of proprietary trading operations of banks, then we could conceivably see opportunities to compete for significant new prime-brokerage mandates coming from hedge funds that would be spun out of banks.
Are 'day-one' investors in hedge funds still amenable to paying two-and-twenty fees, or are they on the lookout for a sweeter deal?
Ehrlich: The majority of our managers continue to charge in a range of one-and-a-half to 2% and 20%, but there is certainly a greater level of negotiation by early-stage investors in all aspects of their terms, whether it be fees, liquidity, lock-ups, or even revenue sharing.
For hedge funds that didn't gate or side pocket, and got treated as ATMs by investors, do you think they will be favoured in future by investors by virtue of their gentlemanly behaviour?
Ehrlich: From what we have seen, few investors have factored this in when considering who to put money with.
Are there more Bernard Madoffs out there? Do you screen the managers who present here at the conference to determine whether they are clean?
Ehrlich: It's guaranteed there are Bernie Madoffs out there somewhere, because if people are intent on committing fraud, then they will do so. That's why we do a substantial amount of screening and due diligence, and there isn't anyone here in Shanghai who isn't a client. We do the best we can, but clearly, by definition, no firm can provide absolute guarantees, and we do not "recommend" managers. Investors need to perform their own due diligence, and to decide for themselves if they want to invest.
Keller: If we have a financing relationship and lend a fund money you can assume we do a lot of due diligence. It's naturally a big focus for us.
If you're a mid-level unspectacular manager, with reasonably good performance - not hot, but not useless - how do you get from the minor league into the majors?
Ehrlich: If marketing is your issue rather than performance, and you're not having success with capital raising, then consult with your prime broker's capital-introductions team. If you're worried that you're not in a sexy space, then my advice is "You are who you are". Don't style drift just because you're unfashionable. That never plays well with investors.
On the other hand, if your performance isn't attractive, then that's a different story. The capital-introduction process isn't meant to absolve disappointing performance. But it can provide very useful insight into how investors are looking at performance, and can help a manager find marketing strategies that are more suited to the performance of the fund.
Keller: Each situation is unique. I know a manager who had the ability to scale, but couldn't make a jump up from $200 million, a number at which people clearly had faith in him. He had a marketer who was perhaps the wrong fit for him. So we sat down in a room, with and without the marketer, and talked it out, how they were positioning themselves and who they'd met. So we helped him rebuild and refocus his marketing strategy.
You have a remunerated third-party capital introductions service (led by Jenkin Leung in Asia) and also a free prime-broking capital introductions service. Given the former commands a fee, and the latter doesn't require any payment, can it be assumed that the remunerated product is better than the free one?
Ehrlich: No. The two products are different. The capital-raising service is not for start-ups. It is for institutionalised firms who want a bigger reach across the entirety of our firm that prime-broking capital introduction wouldn't necessarily reach.
Our third-party capital raising service is not part of prime broking. We have about half a dozen people performing that role and doing a much higher level of due diligence on a handful of hedge funds. In contrast, there are over 30 staff globally supporting prime brokerage capital introduction.