Outsourced trading is an option buy-side firms are increasingly exploring, if recent media reports are anything to go by. What does it entail and why now? In my view there are two main drivers of this trend – one push and one pull.
The push factor is the cost of investing in the requisite staff and technology to maintain an effective and comprehensive buy-side trading desk, particularly at a time when electronic execution and passive investment strategies account for a growing percentage of overall trading volume. In such an environment, the value of an internal trading desk in providing market colour has been compromised to a great degree.
The pull factor is the breadth and depth of capabilities available from outsourced trading providers. At Cowen, for example, not only do most of the traders in the outsourced trading division come with significant experience on the buy-side, but the business offers a range of specialists across geographies and asset classes. In addition, with 25+ traders located throughout the US, London and Hong Kong, it allows for surge capacity, obviating the need for individual buy-side firms to staff to peak levels.
Essentially acting as a buy-side trading desk, outsourced trading providers have recognisably similar operating models to those their clients might have run. We employ a buy-side trading infrastructure, including, for example, buy-side OMS and FIX connectivity to scores of brokers globally
This familiarity extends to the way the trader engages with the market. When trading for a client, we generally send orders electronically to away brokers in their name, and these brokers will settle the trades directly into clients’ accounts. The client therefore retains high visibility on the Street, reinforcing the client’s brand in the broker-dealer community. In certain circumstances, anonymity can be an attraction, and when it is, we can and do trade on a broker-to-broker basis should the client want us to. In most instances, however, clients look for attribution.
The nature of the relationship between a buy-side firm and an outsourced trading provider will be set by the former. In the case of Cowen, we find that our high-touch expertise is most often called on, but we also have access to all the automated trading tools a client may require.
Is there such a thing as a typical outsourced trading client? New fund launches are an enthusiastic adopter. Many of these are, however, spin outs from established firms with a well-defined service expectation and a larger AUM than might otherwise be expected.
Although originally aimed at hedge funds, we are, I believe, at an inflection point when it comes to adoption by established hedge funds and more traditional long-only managers facing increased cost pressures. Cowen is seeing a growth in the number of RFPs from mainstream asset managers. Many of these are prompted by consultants, who alert their clients to the cost-saving opportunities available from adopting an outsourced model.
Among the larger long-only firms, engagement with outsourced solutions is unlikely to be on an all-or-nothing basis initially. In looking to streamline their cost structure, we’ve seen such clients start by migrating one aspect of their operations, outsourcing their trading in specific markets, for example in Europe or Asia.
To avoid conflicts of interest, Cowen’s outsourced trading desk not only resides in a separate location from the firm’s institutional trading desk, but also operates within a different broker-dealer utilising different trading technologies. At the same time, we are able to leverage the firm’s capabilities, as well as our existing relationships with executing brokers, for purposes of research, conferences, corporate access and capital markets activities. The outsourced trading service will also handle all middle and back office support functions, and where required, additional services including shadow reporting, portfolio reconciliation, real-time P&L and risk analytics, pre-trade analytics and trade cost analysis. The solution is much more comprehensive than simple execution.
Sceptics may suggest that the nature of the daily interaction between a portfolio manager and the buy-side firm’s own trading desk would be hard to replicate. In practice, however, even when the trading desk is in-house, the trader is often not in the same room as the PM, and communication depends on Bloomberg messaging, phone, and email. Here again, the PM sets the tone. It’s the job of the outsourced trader to meet the PM’s expectations.