The advantage of “true” outsourced trading

A provider of outsourced trading services for a decade, JonesTrading's global head of outsourced trading, Jeff LeVeen, outlines what a service needs to include to truly replicate what an internal execution trader does as the space evolves to a point where differentiating the service offerings is becoming critical for managers.
By Jeff LeVeen

Jones has been providing outsourced trading services since 2013. We have seen the evolution of the industry first hand, and have actively scaled our offering alongside technology developments and ever-changing client needs.

JonesTrading’s view is simple; outsourced trading (OT) should truly replicate an internal tarder’s role, at a minimum. When done properly, the service should naturally take on additional responsibilities beyond execution. Our approach facilitates both operational and technological responsibilities, which reduce a fund’s pre-trade and post-trade lift. This approach also benefits managers by consolidating both technology and trading costs.

As we highlight below, we believe the investment managers now fully understand and have embraced the benefits of outsouring all, or a portion of, trading to an OT provider. We are now at a point in the industry where differentiating the service offerings is becoming very critical for managers.

Our belief is that the biggest risk to the outsourced trading industry is “substandard” or “not truly” outsourced trading coverage. Firms may market OT but are merely offering an agency trading desk to capture commission for services offered. Outsourced trading is at an exciting inflection point. It is critical for the industry and clients to recognise the differences in approach, and to work with their provider to get setup appropriately.

In order to truly replicate what an internal execution trader does inside a fund and for the PM, analysyts, ops team, compliance team and extrenal providers, the service should include:

Minimising potential conflict

A full understanding of the outsourced trading providers model helps to weigh potential conflict for the manager. Proprietary trading desks, internal dark pools, self-clearing broker dealers, internal securities lending desks, and fundamental research offerings all could create potential conflict of interest for the manager. The manager is entrusting their trading data to the outsourced trading firm and this data must be segregated from these areas of potential conflict.

Anonymity and attribution

A proper OT model allows for complete anonymity of client orders, but is also able to get funds the commisison attribution for the trades they want executed with the brokers providing them services. This is especially true for funds who may be large owners of names (eg. activist) who appreciate that they can enter or exit names without the brokerage community knowing that they are active in the name.

Conflict free cost model

If an OT provider offers a cost model based on commission compensaton on a percentage of the orders handled, the manager is unkowingly creating conflict for themselves. When their outsourced trader is making order routing decisions based on execution cost, it exposes both the manager and the OT provider to best execution scrutiny. When an OT provider needs to force a percentage of the orders to be executed internally for compensation purposes they are clearly not prioritising best execution.

Working inside a client OMS An outsourced firm should offer the ability to manage the client OMS, which includes staging orders, handling pre-trade checks, monitoring all positions, routing to various brokers, consolidating trade files and managing the end of day process.

Access to brokers and liquidity

With connectivity to hundreds of global brokers and liquidity venues, access to liquidity can be maximised, clients piggyback the benefit of all this market and liquidity access that they would not have themselves, simply because no one fund sets up as many broker relationships as an outsourced trading provider has direct access to.

Reduced counterparties and FIX lines

A robust OT provider has built connectivity to hundreds of brokers and venues. The fewer brokers that a fund faces for clearing, the better from a workflow and post-trade perspective. It also helps to minimise counterparty risk concerns for the GP’s and LP’s during their due diligence process. This also consolidates the process and mitigates operational strain by leveraging the OT back/middle office team to assist with settlement work.

Commission management

OT help fund managers budget brokers and ensure the right types of orders are going to those brokers, including the prime brokers, from a best execution perspective. OT providers are also able to act as a soft dollar aggregator allowing to generate orders on orders executed internally or externally at the OT firm.

Commission reporting portal 

Jones has built a proprietary OT portal that provides clients with a depth of information on trading activity, counterparties, commission wallet and best execution.

Trade cost analysis

It is very important for funds to receive a transaction cost analysis (TCA) report at a minimum once a quarter, run by a third party