Enabling alpha: The evolution of prime brokerage

The return of market volatility has created favourable conditions for hedge funds and other alternative asset managers to generate alpha for their clients. In April 2025, the CBOE Volatility Index hit a five-year high¹, as unorthodox trade policies out of the US prompted chaotic trading across the world.

But this was not the only event to raise the so-called “fear index” over the last few years. The start of the global pandemic in 2020 and the introduction of a new monetary policy regime in 2022 were also periods of market stress when alternative investment strategies outperformed².

With volatility once again an ongoing market feature, asset allocators are paying greater attention to alternatives, as a mean to increase exposure to returns that are not correlated to broader markets. As a result, the hedge fund industry, which ended 2024 with assets under management of USD4.5 trillion³, is expected to hit USD5 trillion by 2028⁴.

Growth in the industry leads to a corresponding increase in size and capabilities of their banking partners – the prime brokers, who are entrusted by investment managers to finance, execute and service complex transactions.

“Managers rely on prime brokers to enable their increasingly sophisticated investment strategies – across a growing range of assets and geographies – by providing an integrated offering of financing, collateral management, clearing and execution,” said Loic Lebrun, Global Head of Cross-Asset Securities Financing and Prime, HSBC.

Although hedge funds compose the largest segment for prime brokers, the range of institutions is broadening to include sovereign wealth funds, the alternatives arms of large asset managers, and private wealth investors – such as family offices.

Serving the multi-managers

Alternative investment managers operate across a wide-range of strategies, but two particular fund types have become prominent in recent years: the multi-strategy fund and multi-manager funds, which have multiple portfolio managers within the umbrella of a single fund, each investing according to their distinct strategies.

These funds have proved popular as they present a diversified portfolio that aims to deliver consistent returns over time. Over the five years up to mid-2024, multi-manager funds outperformed the broader hedge fund industry and global portfolios with a 60/40 split between equities and bonds.⁵

The strong returns have made multi-manager funds particularly attractive to investors. Inflows into this kind of fund have made it one of the largest segments of the hedge fund industry. At the end of 2024, multi-manager AUM in the US was USD709 billion, second only to the traditional equity-focused funds, which had AUM of USD1.2 trillion⁶.

A multi-manager fund typically allocates capital among dozens of investment managers. Taken together, the fund has a complex set of investments across a range of asset classes. One way of measuring complexity is by looking at the number of open positions a fund has. A multi-manager fund, on average, has 4,243 positions. To put this into perspective, macro strategies have 2,368, and equity funds have just 1,302⁷.

The rise of the multi-manager fund has increased demands on the banks that serve them. Not only do these funds require multi-jurisdictional capabilities, but they also need deep financial resources and multi-asset services that cover a broad range of asset classes – including equities, fixed income and foreign exchange.

Fixed income financing is a key component of cross-asset prime functionality – covering everything from corporate, government, high-yield and distressed bonds. A fund manager might be long a bond and also have a short position on the bond’s future. They will expect their prime broker to seamlessly offset the exposure on the two securities and provide them with cross-product margin.

But not every prime broker is in the position to offer effective fixed income financing, as it is an asset class that can be balance sheet intensive. There are also only a limited number of banks that have the necessary inventory of fixed income securities to effectively operate in the space.

“Having the capability to seamlessly provide fixed income financing alongside other asset classes is a key differentiator for prime brokers, who are operating in an increasingly demanding environment for cross-asset solutions,” said Mehmet Mazi, Head of Global Debt Markets, HSBC.

Beyond fixed income, a cross-asset platform needs to cover cash equities and FX, as well as a wide range of derivatives products: including equity swaps, futures and options, and FX derivatives.

Size matters

Another important alternative investment trend is the rise of the mega-funds, with a small number of firms accounting for an increasing share of industry activity. At the end of 2024, the top ten hedge had a 9.5% share of the total open positions, the highest level since the data series began⁸.

As the industry grows in scale, so too does its financing needs. Prime brokerage borrowing reached USD2.5 trillion in 2024, more than double the amount seen in 2020⁹. From a strategy perspective, multi-manager hedge funds are the largest consumers of finance, followed by equity and macro funds.

But at the same time, the supply of finance is not as readily available as it was in the past. Perhaps the single biggest reason is that the largest prime brokers have reached financing capacity, limiting their ability to further extend their book. This is exacerbated by other prime brokers leaving the market, which has reduced the number of financing partners available. Regulations around bank capital requirements present another potential tailwind – especially the Basel III endgame standards that will impose stricter Tier 1 capital requirements on globally systemically important banks.

In light of the changing financing conditions, alternative investment managers are working differently with their prime brokers. Most notably, they are looking for partners that are backed by the sizeable balance sheets required to extend the amount of leverage needed by the largest funds.

“As the alternative investment industry grows in scale, so too must the breadth and depth of prime brokers,” Franck Lacour, Global Head of Equities, HSBC. “A considerable balance sheet, combined with the robust risk management needed to effectively deploy it, will be a defining characteristic of the prime brokerage providers that succeed in the future.”

Another aspect of the evolving relationship between a prime broker and its clients is the way that risk is distributed across the ecosystem, which increasingly resembles a two-way street. Prime brokers not only take on risk when financing a fund, they also recycle their risk by transferring it to funds that have the appropriate risk appetite.

International expansion

Although North America accounts for around 80% of global hedge fund AUM¹⁰, the industry is becoming more global, as large funds expand into new markets – such as the Middle East. The region is attractive as it presents an attractive macro backdrop, and financial centres that are offering incentives for hedge funds and other alternatives investors to set up shop locally.

Fund managers are not only actively participating in capital markets in the Middle East, they are also increasingly deploying capital globally from the region, which is in turn driving new investment corridors – creating emerging routes of global investment that further strengthens its place as a financial hub.

The Middle East has a deep pool of capital, with large investors that have a track record in allocating to hedge funds – including large private investors, family offices, and giant sovereign wealth funds. More than a quarter of the world’s top 100 hedge funds have operations in the UAE; and in Dubai, there were 45 hedge funds with more than USD1 billion AUM at the end of 2024, a significant increase on just eight in 2020¹¹.

A widening global footprint means that hedge funds need to work with established prime brokers that can provide access to both developed and emerging markets as well as deep local insight. HSBC’s long history in not only the Middle East, but also in Asia, provides a unique opportunity for fund managers looking to geographical diversification of their prime brokerage providers.

“For investors in emerging markets, the role of a prime broker is more than enabling an investment strategy, as investors new to these markets often benefit from on-the-ground guidance in navigating local rules and regulations governing areas like market access, the use of derivative products, and local custody issues,” said Matt Kiraly, Global Head of Prime Sales, HSBC.

Market access is a case in point. To invest in China’s onshore fixed income market, for example, a fund must decide one of three access channels, each providing differing levels of access.

The Qualified Foreign Investor (QFI) programme for example, grants the broadest access, but requires a license from the regulator, while access via Bond Connect is more straightforward, but with a smaller range of tradeable securities. The prime broker can help institutional investors new to the market to find the access channel that best meets their needs.

Conclusion

Diversification is a persistent theme across all the major alternative investment trends: multi-manager funds provide a diversified portfolio for their clients, larger funds are partnering with a diverse range of prime brokers to meet their financing needs, and many funds are diversifying into emerging markets.

And at every step of the way, the prime brokers will need to expand to facilitate alpha generation and deliver services beyond liquidity and execution for the world’s most sophisticated investors.