Networks for Alpha: Prime Broker Connections and Hedge Fund Manager Selection

Abstract

Using the setting of funds of hedge funds (FoFs), we show that prime brokers (PBs) help investors search for informed hedge fund managers. We find that FoFs overweight their investments in hedge funds serviced by their connected PBs. This PB bias is larger when the cost of hedge fund due diligence is higher relative to capital and when the FoF's management firm operates a larger hedge fund business with greater potential to generate prime brokerage revenues. We also show that FoFs select PB-connected hedge funds at an information advantage and that FoFs with a larger PB bias exhibit superior performance.

Keywords: Hedge funds, prime brokers, information, due diligence, funds of funds

JEL Classification: G11, G14, G23