Unlocking the edge

Outsourcing execution can mean firms focus on parts of their business where they feel they can add the most value, whether that be the investment process, clients or other key areas of differentiation.

Outsourced trading has evolved into both a defensive and proactive move for fund managers amid a wave of pressures and opportunities in this current economic, regulatory and cost spiking environment. 

‘Proactive’ in the sense that there are service providers out there that may offer a superior breadth of geographic and asset class coverage, with large networks and extensive relationships. These providers have experienced teams with ample knowledge of the inner workings of a buy-side desk and different parts of the cycle, and large technology budgets to invest in innovation.  The result is a level of service and execution quality available from external specialists that is often far higher than could realistically be delivered using only internal resources.

Additionally, ‘defensive’ in that outsourced trading has become a way to counter the rising cost and fee pressures through a supplemental or full partnership. This enables asset managers and hedge funds to reconsider which aspects of their investment process are truly proprietary in nature versus which are commoditised and can be outsourced.

Analytical, portfolio management, quantitative and business management resources are increasingly taking priority over additional execution resources, with some activities being outsourced to very well-resourced external execution desks. Increasingly, some asset managers are coming to the conclusion that the execution function does not need to be 100% in-house.

“COOs, CFOs and others in the C-suite who are considering how they can reduce costs and maintain performance are realising that outsourced trading is a viable option,” says Jonathan Slavin, head of Americas, UBS Execution Hub.

“When fees are compressed at an asset manager, you think about costs, and while the cost of hiring a trader in an automated world remains relatively the same, the business has become much more commoditised.

“Think of the construction of larger asset managers: PMs either generate the orders themselves or they have a team that does that order generation and then passes it off to the trader. We’re seeing a rethinking of the order generation process by tapping into the expertise of an organisation like ours where you can utilise a pass-through commission pricing model.”

With fee pressures weighing on funds, the costs of hiring multiple traders across various geographic locations on top of systems, technology upgrades and data feeds become apparent. This is why a hybrid model – often referred to as co-sourcing or supplemental trading – is taking off with a range of fund management firms, both large and small.

Concurrently, the pandemic marked the end of an era of placing an overemphasis on teams being physically located next to each other. With it came the realisation of the benefits an outsourced trading provider can offer through liquidity, data and technology, which outweigh the importance of proximity.

“Most of the clients that we deal with have a trading desk and we’re supplementing them in other regions where they may not have a presence, or where they may not have expertise in a specific asset class,” explains Slavin.

“Increasingly, portfolio managers are getting into the same comfort zone with outsourcing execution that they would have if they had somebody in house.”

There is also a trend of having fewer, but higher-quality, relationships and there are larger providers who can also offer prime broking, cap intro/consulting and research as part of a broader relationship.

All of the above factors have led to a new trend in the ever-maturing outsourced trading space. What was once an option confined to smaller hedge funds has expanded, attracting larger managers with each passing year, with the trend now increasingly tempting those in the $100 billion-plus range and new entrants from the world of asset allocators, family offices and insurance funds.

“We’re having conversations with$100 billion-plus asset managers. If it’s not for everything, it’s for part of their model,” adds Slavin. “Even firms with sophisticated trading functions, such as insurance companies, are considering it.”

Alongside the aforementioned headwinds and opportunities, which are becoming fairly well-known, another factor is also steering the buy-side towards outsourced trading, and that is the pressure to develop data-driven algo wheels to optimise their broker routing decisions. 

The situation is creating a technology arms race; however, firms are finding that their own data set isn’t big enough to be statistically significant and that they often don’t have the quant or dev capacity to build and maintain an intelligent data-driven model.

“This is another area where UBS Execution Hub is differentiating through investment in a team of quants who have worked to build an AI-driven, machine learning model that leverages UBS’s vast data set of both wealth management and asset management executions,” says Chris Blackburn, head of EMEA, UBS Execution Hub.

“Like a dynamic algo wheel – for any given order and any given urgency, it will determine what the optimum strategy to employ would be, based on empirical data. Then for that chosen strategy, it will determine which broker’s algo is likely to result in the best execution outcome.” Blackburn explains.

He adds, “All of this is based on an empirical data set which, importantly, evolves over time.  Our brokers are continually improving their models, and this enables us to stay on top of monitoring those improvements.  We have abundant data available because of the sheer scale of the trading we’re doing with the Street, and we have a team of seven full-time quant/devs building and maintaining our model. We make this resource available to our clients so they don’t need to duplicate the work.”  

When assessing how to deploy finite resources, firms are increasingly looking at where budget can best be allocated and in some cases this is leading them to the conclusion that more value can be derived from investing in hiring analytical, portfolio management, technological or business management resources in-house, while a third-party can then be deployed for execution.