Land of Opportunity By Imogen Rose-Smith

   We used the results to compile the 2006 Alpha Awards, our second annual ranking of the world’s top hedge fund service providers. There are, however, a few significant differences from last year. We asked hedge funds to rate onshore and offshore law firms independently — to match the way funds view their distinct services — so we now have winners in five major categories. We have also added Alpha Awards for the top technology service providers in four areas vital to the long-term success of any hedge fund: investor relations management, portfolio management and accounting, risk management and trade order management.

   In addition to ranking the top firms based on overall quality of service in the five major categories and four technology areas, we give Alpha Awards to the leading service providers in 27 more-specialized categories, such as fund accounting for administrators and algorithmic trading for prime brokers. We even break out a separate ranking for the top service providers based on voting by the more than two thirds of the firms in the Hedge Fund 100, our list of the world’s biggest single-manager hedge fund firms, that participated in the survey. For more information on the methodology, see “Compiling the Ranking,” below.

   The voting in this year’s Alpha Awards was often extremely close and sometimes at odds with conventional wisdom. In several categories the biggest or best-known firms do not win. And even in businesses where the industry leaders finish on top, it is clear that their competitors are inching closer.

   Overall the bulge-bracket banks fare well. Morgan Stanley, the only repeat winner from 2005, narrowly edges out Goldman Sachs for the prime brokerage crown. Goldman, however, takes top honors in hedge fund administration, unseating last year’s winner, International Fund Services, which drops to No. 4. When it comes to law firms, size doesn’t necessarily matter. Chicago’s Sidley Austin, which has more than 1,600 lawyers worldwide, wins among onshore firms; the much smaller Cayman Islands–based Ogier, with just 145 lawyers, takes the offshore prize. Another Chicago firm, BDO Seidman, finishes first in accounting, handily beating last year’s winner, Rothstein Kass & Co., which falls to No. 2.

   Hedge funds in general are demanding clients. With the phenomenal growth in hedge fund assets — today at least 20 hedge fund firms each have at least $10 billion under management — many managers are looking to use their increased economic clout to ensure they get top service.

   “We use almost every major prime broker,” says Robert Caruso, managing partner and chief operating officer of New York–based Highbridge Capital Management, which manages $13 billion in assets and has ten prime brokers. “The firms that provide the highest quality services and the most value-added get the biggest portion of our business.”

   As different breeds of hedge fund service providers start to offer similar services, funds are able to pick and choose among them for things like tax advice and succession planning. “You can go to a leading prime broker with a tax issue, but if you do not get the right person, then maybe a small law firm or your accountant is going to be better,” says Scott Schroeder, general counsel at Balyasny Asset Management, a $600 million Chicago-based multistrategy hedge fund. “You just have to find the right person.”

   For UBS’s Ehrlich the fungibility of service providers creates opportunity. Four years ago, before he joined UBS, a strategic review commissioned by the bank’s senior management concluded that prime brokerage was one of two areas in which the firm was significantly lacking.

   The study also concluded that hedge funds were of the biggest growth opportunities.

   "It became clear that the effort to create one of the world's leading prime brokerage businesses grows hand in hand with having a leading hedge fund franchise," says Ehrlich, who was hired from Goldman in May 2003 to help lead that effort. UBS, which climbs one place to No.4 in this year's prime brokerage ranking, believes it can overtake Goldman and Morgan Stanley. Ehrlich says that the banks that got in early will not necessarily be the winners in the long run.