The program tracks the communication hedge funds have with the teams at banks and broker-dealers and uses natural-language processing to determine which broker was the most helpful to the fund — and funds pay them accordingly. 

Erkin - Business Insider
Erkin Adylov, CEO of Behavox, is quantifying the relationship between the buy-side and sell-side.

Hedge funds are some of the world’s most sophisticated investors around.

But the way they go about determining what, exactly, their relationship with brokers like Goldman Sachs or Morgan Stanley is worth is “completely subjective,” according to Erkin Adylov, CEO of communications analytics company Behavox.

At the end of each quarter, hedge funds hold meetings to tabulate the commissions they need to pay their bank brokers. Adylov, who previously was a portfolio manager for Man Group and an equity analyst for Goldman in London, said “the way the commission wallet is distributed is purely finger-in-the-air. It is not objective at all.”

Two years ago, a large fund asked for Adylov’s help in quantifying its relationship with broker. Since then, Behavox — which has historically worked with funds’ compliance teams to track internal communications — has been perfecting a machine-learning tool known as Broker Vote. The system monitors the communication hedge funds’ portfolio managers and analysts have with their brokers, and looks to rank them based on quality.

Currently, Balyasny and Marshall Wace use the tool, and Broker Vote is currently used to determine which banks receive $200 million in commissions, industry sources say. The tool will launch to a broader audience at the end of May. Adylov hopes for that number to be between $500 and $600 million by the end of the summer.

Sources said that Citadel also uses Broker Vote. However, after this story was published, Citadel said it doesn’t use Broker Vote, and Adylov denied that Citadel is using the tool. Marshall Wace and Balyasny declined to comment on their relationship with Broker Vote.

Hedge funds are keeping an eye on commissions

With hedge funds’ largest investors demanding lower fees, managers are searching for ways to keep their margins high in a world where the once-ubiquitous 2% management fee and 20% performance fee is now rare. Keeping a closer eye on their relationships with brokers could be one way to cut costs.

Banks’ prime brokerage units have historically been lucrative businesses. That’s changed in recent years, as banks have seen the commissions they get through their relationships with hedge funds and other large investors fall by 45% since 2010, according to a 2018 report from Greenwich Associates. A new European regulation forcing managers to spell out the commissions they pay for research has further driven down the amount hedge funds are paying banks.

The dwindling commission pool paid to banks — it was roughly $8 billion last quarter in the US — has fallen each of the past eight years, and this tool is a way to take the emotion out of the process, said Richard Johnson, vice president of Greenwich Associates’ market structure and technology unit.

“Traders get comfortable with the brokers that cover them, and have a personal relationship, and this can insert a more objective view” when determining what commissions are paid, said Johnson.

“Hedge funds are very, very much about all things data anyways, and so the more they can get data about their relationships and quantify them, the better.”

Behavox ranks the quality of hedge fund-broker communication

The system takes the same Behavox technology that many funds’ compliance teams already use to monitor internal communication and extends it to the communication hedge funds’ portfolio managers and analysts have with their brokers. Call logs, emails, Bloomberg messages, calendar invites, access to corporate events — it’s all tracked, reviewed, and sorted by the Behavox machine-learning technology.

The new addition to the technology is Broker Vote, which then ranks the hundreds of brokers funds work with on a basis of how helpful they are. The big difference between Broker Vote and other attempts to do this, says Adylov, is that Broker Vote uses buy-side communications data and ranks brokers based on quality, not quantity.

“Are you emailing someone on Saturday night when you don’t email anyone else at that time? They must be your go-to person, and the system will reflect that. Have you emailed every bank a thank you except one? The system will reflect that,” Adylov said.

Some banks might see a drop in commissions thanks to this tool. One fund that recently compared its own ranking with Behavox’s and found it had been underpaying Jefferies while overpaying some of the larger banks, based on Broker Vote’s analysis, sources said. A representative for Jefferies could not be reached for comment.

The goal of the tool is that funds will dole out their commissions based on services rendered, not reputation, Adylov said.

“There’s no more commissions for taking someone out to dinner,” Adylov said. “If it’s an old boys network, then the large banks are always going to win. But that’s not the future. The future is all about objectivity and being more data-driven.”