Around the start of the 2010s, when the financial industry rebuild was in full flight, a quiet but meaningful structural change was starting to take place in the trading world: asset managers (“the buy side”) were seeing the merit of having better in-house trading functions. Part of my own professional journey involved making this transition.
Driven by better price discovery on block crossing, an ever-growing maturity in the Electronic Trading space, OMS/EMS enhancements and an improving understanding of Transaction Cost Analysis—not to mention an abundance of post-GFC talent—funds began to build or upgrade existing functions.
While many firms already had well-established trading desks around the world, as the value of the implicit (market and stock movement) and explicit (commissions, human and technological capital) costs became better understood and measured, there was a requirement to move away from the traditional “order clerking” function so often associated with the placement of a fund manager’s orders into the market.
The remit of the modern buy side trader is also much more complex, much more important, now that execution is seen as a key part of the overall investment process.
Outside executing orders—and in doing so, adhering to Best Execution standards—they can have responsibility over ideas generation, the assimilation and delivery of market- and stock-related content to PMs, the assessment of broker efficacy, settlement matters, trading performance measurement, regulatory oversight, development of Electronic Trading capabilities, platform maintenance and enhancements, and industry/market stewardship. Furthermore, all this comes amid a heightened environment of operational and regulatory risk.
But in the past few years we have seen a second, quiet change taking place to the trading landscape. A meaningful, evolutionary step. For asset managers, the cost of servicing this model has become significant to the point of it being burdensome, and in fallow periods of operational activity the fixed cost of running a trading desk has come into focus.
Larger operations have been reducing net headcount, smaller ones have not upsized, while start-ups have elected to not establish a trading presence at all.
In doing so, and in line with other non-core investment functions such as Operations, Compliance and Legal, investment firms are considering outsourcing as a viable, practical option.
During my time building and leading large-scale institutional buy side desks, the cost dilemma of fixed human and technological “pipework” always left me questioning its feasibility, even if the value proposition was well understood by the investment organisation it served. In having a flow-based business at its core, notwithstanding the other parts of a trader’s remit, how can you attach a value of having a person in a seat that is not P&L- or revenue-generating?
I would often reflect on the merit of having 4-5 traders doing very little, especially at an estimated, fully-costed figure of around US$500,000 per head [Opimas survey]. In the hedge fund space, it has been surveyed [by Citi] that a typical fund requires $310m in AUM to enable their 2% management fee to cover all their regulatory and operational costs, with execution a major component of this.
Enter the era of the dedicated outsourced trading firm. Without losing the central credo of Best Execution as well as the multifaceted service provision an in-house trading team would provide, we now have providers offering everything a fund manager needs. Suddenly, the fixed cost becomes a variable one; you are only paying for service as and when you need it.
The model is nuanced however: while most outsourcing firms will claim to be extensions of the asset manager’s trading desk, often their service will be embedded in an existing brokerage model, or part of their custodial service. Very few are set up purely to be an outlet (or extension) for orders, who in turn then deploy their vast network of sell side partners. Potential conflicts lurk, due diligence is needed.
While in the US and Europe the concept of outsourced trading has largely been accepted, for local Asian funds it is still extremely nascent. Most managers are still choosing to build their own capabilities, unaware of the burgeoning service provision from a highly effective outsourcing option.
Trading in Asia is a particularly challenging triangulation of cost, regulation and operational factors. For the past ten years especially, its lack of a single regulatory and market structure framework (in the way, say, MiFID II provides for Europe ) means execution has become a complex mosaic of super-themes (China access and SFC Electronic Trading regulations, for example) and tactical developments (per-market algorithmic behaviours).
As the need for cost efficiencies and having a clear, coherent strategy grows, the option of outsourcing some or all of a trading function has become extremely compelling. Picking a reliable, long-term partner will be key.
David Rogers is a Managing Director at Outset Global, based in Hong Kong. One of the original and leading outsourced trading firms, Outset provides execution services to institutions, hedge funds, asset managers and family offices, equipping them with a cost-effective solution across global equity markets, along with capabilities in the secondary private securities market. They are independent, broker-neutral and unconflicted, the result for clients being cost efficiency, reach and true flexibility in execution and commission management.