Adam Bradbery in the Wall Street Journal reports that the environment is becoming more difficult for hedge funds looking to raise money. Apparently many managers are looking to hook up with established firms rather than go through the hassle of setting up an independent fund operator.

“The environment for hedge funds is tighter than in previous years with inflows reduced in 2005 compared with 2004 and 2003,” said Jack Inglis, Morgan Stanley’s co-head of prime brokerage in Europe. “The inflows we have seen have been seeking out established managers with track records rather than start-ups.”

As established hedge fund operators have gotten larger, they have taken on more “prime” broker relationships. Serena Ng in the Wall Street Journal reports on a survey that shows 56% of hedge funds with $1 billion or more in assets have more than four prime brokers.

While small, start-up funds by necessity use only one prime broker, larger firms find a number of reasons to use multiple prime brokers. Fears of confidentiality and the ability to induce competition drives hedge funds to diversify. This has opened up the market (to a degree):

“There’s no doubt that the prime-brokerage industry is an oligopoly right now,” says Christopher Kundro, managing director of consulting firm BearingPoint Inc. “But the move toward multiple prime brokers has opened up the market for smaller players, who may not offer the same broad-based services as the big firms but specialize in different areas.”

The hedge fund world is becoming more complex. The rapidity in which capital flows from asset class to asset class, and from manager to manager forces investors to try and optimize their service provider lineup. Primer broker services have become major profit centers for the major investment banks. It will be interesting to see if this movement puts a dent in their business (and income statments).

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