Interest rates in major economies have risen dramatically in the past year, in a number of cases reaching levels not seen since before the 2008 financial crisis. As a result, portfolio managers face a radically different market dynamic, one where the assumptions that were built into a range of investment approaches no longer automatically apply. 

At the same time, many fund managers, until last year, had little experience with this kind of environment. Before interest rates started to climb, equities had enjoyed a nearly two-year bull run. But the past year and a half have been much choppier, as the risk-on trade has ceased to be the default position.

Andrew Rae-Moore, Co-Head of Europe TD Cowen Prime Services, Europe provides insight into how a prime broker can help during such turbulent times and the key factors to consider when selecting which prime brokers to have in your stable, given the current economic climate.

1.    Consulting 
One of the main ways a prime broker can provide support is through consulting. At TD Cowen, we see a big part of our role as being there to explain situations that might be novel to some fund managers, particularly in the case of emerging funds. For instance, the upward shift we’ve seen in yield curves has created fresh incentives to do more than keep excess cash in money market accounts. But not every manager will know what opportunities there are, or what might be involved in seeking to tap into them. Also, not every prime broker has the bandwidth to engage in such in-depth conversations with all of their clients. 

2.    Added value
A proactive approach is vital. As most funds had grossed down exposures since the latter part of last year, many began to carry meaningful credit balances more consistently. As an example, this provided us with the opportunity to engage with our clients, alert them to the better rate spreads, and add value with our capabilities and service-oriented approach.  

Select a prime broker that prides itself on providing added value. If they have a large team of veteran traders, you will be able to draw on their knowledge, experience and trading capabilities. One of the ways in which a prime broker can provide even greater support for in-house trading desks is through outsourced trading – a service which is on the rise as a proven, quick and cost-effective way for fund managers to source expertise, experience, global reach, deep liquidity and cutting-edge technology.   

3.    Service levels & capabilities
A key question that managers – whether they are large or small funds – should be asking as they consider adding a new prime broker is what kind of service does the prime broker provide? They should also check whether the prime broker has the right suite of services to help a firm take advantage of opportunities as they arise.

Bulge bracket providers can obviously perform well on both of these counts, but they may face constraints in terms of high-touch service provision due to the sheer number of clients they have to support. They may not always be able to provide the level of TLC that some fund managers would want. Smaller prime brokers, however, may perform well in terms of service but not so well on the breadth of offering. The sweet spot is when a prime broker fits the bill with regards to both aspects. For new funds with less-experienced managers, the combination of service and expertise can help them explore unfamiliar terrain quickly and with minimum fuss.

All prime brokers will undoubtedly talk positively about their focus on customer service, but the service a fund receives can vary, depending on the size, personnel, culture and business model of the provider. For instance, large bulge bracket providers may have to reserve more of the personalised service for their biggest clients. Many of them simply don’t have the bandwidth to handle detailed, time-consuming questions from all of their clients. To put the numbers into perspective, when Credit Suisse exited the prime brokerage market, it had about 1,800 clients. At the other end of the spectrum, some smaller prime brokers may not necessarily have the experience or expertise to deal with every request and scenario. 

What’s changed?

Why does this matter more now than before the past year’s upheaval? Because so many managers, particularly those who have been focused on equities for the past decade, have incentives to look more seriously at other asset classes and could benefit from having a prime broker that can answer their questions and facilitate new types of trades. Most of the larger prime brokers are unlikely to spend the time required to discuss with all of their clients, for example, the pros and cons of something as simple as switching into very short-term treasuries from cash or money market funds in the current environment, how that would impact their workflows and how it may benefit their fund. 

These kinds of questions may be obvious for funds that are familiar with interest rate products and strategies, but there are plenty out there that don’t have that experience. Having the capability to then facilitate the transaction for the client in an efficient and cost-effective manner completes the service.

Stay a step ahead

Last year was marked by a sudden jump in inflation, putting strong upward pressure on global interest rates. At the time of writing, the inflation situation appears to be calming in many developed economies, which in theory takes some of the pressure off. But no one has a crystal ball. 

More to the point, there is a sense that the interest rate genie is out of the bottle. After short-term rates hovered close to zero in the United States for many, many years, yield curves around the world have now shifted. That creates both new possibilities and new pitfalls for funds. Managers looking to exploit the former and avoid the latter can benefit from a prime broker that knows its way around the credit markets.