Land of Opportunity The $1.3 trillion-plus hedge fund industry has been a bonanza for accountants, administrators, lawyers, prime brokers and technology providers. Our second annual Alpha Awards reveal which firms deliver the best service. By Imogen Rose-Smith

   On a bookshelf in his Midtown Manhattan office, Alex Ehrlich, global head of prime services at UBS, has a copy of The Innovator’s Dilemma, a management training staple that seeks to explain why leading firms — innovators in their fields — have often failed. For Ehrlich, who joined UBS from Goldman, Sachs & Co.’s renowned prime brokerage group just over three years ago, the insights into computer hard-drive developers are particularly instructive. The author tells how during the period from 1975 to 1990, each generation of leading disk-drive makers was wiped out as companies failed to adapt to innovation, and no one firm was able to maintain the top spot for very long. To Ehrlich’s way of thinking, the hedge fund services business is entering a similar period.

   Hedge fund services in general, and prime brokerage in particular, have long been dominated by a handful of names. U.S. investment banks Goldman and Morgan Stanley have dominated global prime brokerage. Among onshore law firms, New York’s Schulte Roth & Zabel has long been the name to beat. Among accountants, Ernst & Young pioneered hedge fund services. And Citco Fund Services has been the dominant player when it comes to hedge fund administration.

   Today, as Ehrlich and others see it, the titles are up for grabs. For its part, UBS has already spent more than $500 million to build up its prime brokerage services group in the past four years, including a $250 million acquisition of rival ABN Amro’s prime brokerage operation. The big Swiss bank, which has a separate pending deal to pay $386 million for ABN’s futures and options clearing business, has its eyes on only one prize.

   “We are definitely competing for first place,” says Ehrlich. “We are not investing in this business to be third best.”

   UBS is not alone. Lehman Brothers, Deutsche Bank, Merrill Lynch and Credit Suisse are all significantly ramping up their prime brokerage operations. Meanwhile, the race is on among Goldman, JPMorgan Chase & Co., Morgan Stanley and others to develop or buy fund administration businesses so that they can compete with the likes of Citco. Smaller law firms are taking on, and winning business from, the more established legal names. And the Big Four accounting firms are losing points to smaller rivals.

   The reason so many are throwing so much effort into the race for the top hedge fund service provider is clear: money.

   The $1.3 trillion-plus hedge fund industry is a bounty for those that provide managers with essential services like auditing, fund accounting, reporting and securities lending. According to Brad Hintz, senior analyst with New York–based Stanford C. Bernstein & Co., the big three — Bear, Stearns & Co., Goldman and Morgan Stanley — generated, in aggregate, more than $3.6 billion in pure prime brokerage and related net revenue in 2005. But the real money comes from other services, like trading and structured financing. Hintz estimates that hedge funds generate 30 to 35 percent of equity trading commissions.

   To judge which firms are rising to the top and which ones are falling back, Alpha turned to the managers that use their services. This spring and early summer, we surveyed hedge fund firms around the globe, asking them to rate their accountants, fund administrators, lawyers and prime brokers. More than 1,000 hedge fund management companies participated in the survey, representing $1 trillion in single-manager assets and $250 billion in funds of hedge funds. They assessed their service providers on more than 200 aspects of service, such as the responsiveness of personnel and the reasonableness of fees.