This article originally appeared as FLASH FRIDAY on Traders Magazine, a publication of Markets Media Group. FLASH FRIDAY is a weekly content series about the past, present and future of capital markets trading and technology. FLASH FRIDAY is sponsored by Instinet, a Nomura Company.
In recent years, outsourced trading has become mainstream, with asset managers choosing the offering to improve performance and efficiency as well as manage their costs.
Interest in outsourcing has remained healthy, so it is difficult to determine whether recent trends such as increasing levels of complexity, market volatility and uncertainty are impacting outsourced trading, Grant said. Johnsey., Head of Integrated Trading Services (ITS) for the Americas at Northern Trust. “It seems that the trend towards trade outsourcing has gained enough momentum that it is now developing independently of global macroeconomic events,” he added.
Nonetheless, Johnsey said the widespread deployment of buy-side trading desks is a “relatively new phenomenon.” Today, markets are performing better, the investments needed to maintain a trading desk are accelerating, margins are shrinking and regulatory changes have favored outsourcing models. “So, in effect, outsourced trading allows asset managers to return to a time when they focused primarily on portfolio construction and capital raising,” he said.
Conversations about outsourcing are also growing – asset managers are thinking about how to outsource more than just trading, he said. “We are also noticing increased interest in outsourcing parts of the investment process,” he added.
Aaron Hantman, CEO of Tourmaline Partners, said industry trends are driving demand for outsourced and incremental trading solutions. He said more than 40 firms now claim to belong to the “outsourced space,” adding that the industry landscape has broken down into three broad categories: sell-side prime brokers; guards; and Pure-play independents. “Others” would include a handful of smaller stores, some European asset managers and some outliers in the form of big-name sell-side execution offices, portfolio/wealth management offices, etc., he said. Explain.
Outsourcing models
Outsourced trading solutions can vary widely and be customized, between different vendors and even within the same company, Johnsey noted.
Solutions can range from completely outsourcing all trading and analytics to on-demand items. Johnsey thinks the key question to ask [for asset managers considering outsourcing] is: “What is the optimal future state for our investment management business?” And from there, other questions and considerations will surely follow, he added.
Hantman said the needs of each investment manager may differ, adding that the first question to consider is whether a manager is looking to outsource entirely or if they are looking to complete their scope. “Other issues to consider are the specific reasons for engaging external support,” he said.
He described the typical needs (use cases) of a manager which may include:
- Extend reach to liquidity, color and research information
- Assist with small cap/tightly held/illiquid names
- Negotiate offshore markets
- Troubleshoot Bandwidth Issues
- Gain expertise / access to greater high and low contact trading solutions
- Anonymity – help reduce information leaks
According to Shane Swanson, director of research at Coalition Greenwich, the growth in the use of outsourced trading firms to complement an institution’s trading desk, whether to access skills, expertise, market color or an additional bench depth, is “a rising trend”. .
Each manager should determine their own needs, but outsourced trading can help companies reach different markets or access more asset classes than their in-house office, he said.
Additionally, institutions have been looking for ways to complement their own efforts and may find outsourced offices as a viable solution, he added.
Jeff LeVeen, Managing Director, Global Head of Outsourced Trading and Co-Head of Core Services at Jones Trading, agreed, saying there is definitely more redundancy for in-house trading desks. ” he said.
Johnsey added that the emergence of different outsourcing models, tailored to the needs of the asset manager, remains a significant trend. “As the asset management industry has embraced outsourcing some or all of its trading activities, the solutions available naturally continue to evolve and grow,” he said.
Benefits and risks
Outsourced trading offers investment managers a cost-effective way to run their business, while providing direct access to liquidity and market information, LeVeen said.
However, it is not volatility that is driving the demand for outsourcing, he said, adding that the demand for outsourced trading was still there.
If asset managers outsource, they don’t have to pay an in-house trader, which frees up resources on their management fees, he explained.
LeVeen thinks cost isn’t the main benefit of outsourcing: “I think the benefit is honestly scale.”
He added that fund managers are missing trade flows, market color and outsourcing firm research. “They’re on a shoestring budget, they only have so many brokers they can work with.”
According to LeVeen, execution and expertise are important. “That’s why we’ve taken our time to scale this business appropriately and put the right people in the right seats with the right backgrounds so that we can seize these opportunities.”
For Tourmaline’s Hantman, scale, reach and a global footprint are of significant importance when sourcing liquidity, information, color and news. “While there may be economic benefits to outsourcing and complementing the trade, we believe the primary mission should be to improve workflow and the ability to achieve best execution. This includes expanding a firm’s reach to liquidity, information, color and research,” he said. The risk for any investment manager would be to hire a firm that cannot provide the above, he said, adding that no manager should compromise best execution when looking to cut costs.
According to Swanson, the scope and scale of the outsourced business are major considerations, along with the coverage model they provide.
He said on the benefit side, asset managers can access more markets and asset classes, deeper pools of liquidity and resources, and additional transactions to support their own efforts. .
“On the risk side, standard vendor rules of engagement apply, with the added need to ensure your vendor is getting the best execution results on your orders,” he said.
The main benefit of outsourcing is that it allows the asset manager to focus on functions and activities that genuinely generate alpha or improve their ability to distribute, commented Johnsey of Northern Trust. Outsourcing trade offers well-understood defensive benefits, such as cost savings, workflow efficiencies, reduced trade errors, and improved business resilience.
“Outsourced trading can also bring greater depth and expertise to an investment manager, along with increased resources and better scalability, especially when AUM fluctuates,” he said.
The risks of outsourcing include the potential for errors during the process of switching to the outsourcing model and selecting your outsourcing partner, he added.
According to LeVeen, the big risk is information leakage. “There are many companies that have their business activity outsourced 10 feet away from their other activities. “If I am a customer, I would like fewer eyes to see my orders. don’t need an entire sales team that has visibility into what I’m doing,” he said.
LeVeen said there is a lot of information a client exposes to a broker. “I would want to engage with a company that I know is aligned with my best interest and does not take an exclusive position around my orders or the value of other customers,” he commented.
Overall, he thinks the risks are greater for managers who do not engage in outsourced trading.
Johnsey said there is an awareness that outsourcing enhances controlled cost growth, adding that there is also a growing awareness that outsourcing can be a force multiplier, using capabilities , resources and network effects available through the outsourced trading desk.
“Trading is after all a large-scale business, and asset managers are realizing, as the pace of change accelerates, that there is real benefit in leveraging a larger trading operation. important,” he concluded.
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