Bright Outlook For Prime Brokerage

As most hedge funds sail through the market turbulence with colors flying, banks' prime broker units are emerging as a safe career harbor within the sell side.

Prime brokers are major beneficiaries of the hedge fund sector's ongoing expansion, says a new report by TABB Group, a capital markets research and strategic advisory firm.

The study of 61 U.S.-based hedge funds estimates that prime broker revenues from hedge funds will exceed $11 billion this year, up 15 percent compared with 2006. What's more, authors Matthew Simon and Monica Schulz project that prime brokerage will overtake banks' cash equity business within two years.

"TABB Group estimates industry revenues generated from financing, stock loan, custody and other prime services will surpass other institutional business lines by 2010, in particular the cash equity business, which is hovering around $12 billion a year," says the report, as quoted in FINAlternatives, a newsletter that covers alternative investments.

The study acknowledges about half of all hedge funds have felt some negative impact from the volatility that began last year, and many of these funds are taking some chips off the table and adopting a "wait and see" mentality toward the markets. However, it says, "Generally, hedge funds are in expansion mode." Many plan to open offices around the globe. And the capital that continues to flow in from institutional investors will spawn additional fund launches, TABB says. As a result, "as the hedge fund industry continues to grow, and other asset management businesses attempt to compete more directly with hedge funds, the importance of prime brokerage will only continue to rise.

The average hedge fund's assets under management climbed to almost $4.5 billion this year from $1.85 billion in 2006, according to Adam Sussman, TABB Group's director of research.