The trading desk is dead – long live the trading desk.
Hedge funds’ push towards outsourcing continues, as the front-office is now receiving the service provider treatment. But despite downward pressure on fees and the unbundling requirements brought on by Mifid II , trading was one aspect of fund management unlikely to go on the chopping block – until now.
Outsourcing pressures have already affected infrastructure management, including cloud and data centres, fund accounting, administration, and data. These were among the first functions to go for smaller managers: according to HFM Technology’s November monthly survey, 62% of managers outsource them, while 35% delegate fund accounting and administration, and 24% farm out data management.
In contrast, funds have either considered trading a core function or merged it with portfolio management, tasking hybrid PM/traders with executing their own strategies.
But attitudes appear to be shifting: 4% of respondents to the survey indicated that their firms outsource at least part of their trading volume, while 7% said their funds outsource trade analytics.
As the buy-side reconsiders its relationship with the trading desk, a crop of enterprising firms has sprung up to offer outsourced or – in some cases – supplemental trading.
The nature of these relationships varies, but broadly, they can be separated into two tiers. Some funds will outsource part of their trading flow, while others will outsource certain strategies – a strategy focused on Chinese equity, for example, will depend largely on access to mainland Chinese exchanges and the fund operating it will likely find it more efficient to outsource to a third party, as opposed to hiring a local trader.
According to a recent TABB Group survey of outsourced trading firms, roughly 44% of buy-side firms outsource to ensure night-time coverage, 15% rely on the wider broker network provided by a trading vendor and an equal number use these services for back-up trading when members of the desk are away. Emerging markets coverage is an equally popular motive, possibly due to the complexity of trading in these markets.
Andrew Caplan, head of outsourced trading at INTL FCStone, believes that the practice is no longer just about replacing the trading desk, but also about supplemental trading amid pressures to cut costs and a dearth of buy-side trading talent.
He says: “There are significant costs associated with employing a trading team internally, be it salary or benefits, as well as tech costs, office space and so on. The cost of managing a large team also shouldn’t be ignored.
“But now that you can get very, very senior, experienced buy-side traders for a fraction of the cost of employing them internally, it becomes a very compelling proposition. The need for that senior expertise is there, but often the ability to attract that talent is reduced, based on the dynamics of the marketplace.”
Outsourced trading 2.0
The demand is no longer limited to small and start-up managers, according to Caplan.
“Outsourced trading 1.0, which has been around for a while, was really targeted at small-to-mid-size managers and aimed to save costs. A new version of outsourced trading has emerged in response to a need for expertise – the role has changed. Having an understanding of electronic systems is not necessarily a need that was there 10 years ago,” he explains.
Andrew Walton, head of European business at London-based trading specialist Tourmaline Partners, echoes this sentiment. He says clients cite anonymity and minimising information leakage as key reasons to direct orders through an outsourcer.
“Wherever you are on the AuM scale, there is now no reason not to interact with an outsourced firm,” says Walton. “Previously, it would have been for fund managers that were launching or small managers around $100m-$250m in AuM, where technology spend was too high. Now, it doesn’t matter if your AuM is $10m or $5bn. Firms will use the service for coverage and anonymity. A well-known firm might have a large trading desk in-house, but they cannot afford the potential market impact of trading under their own brand.”
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