January marked the 10-year anniversary of the founding of Tourmaline Partners. When you think about the past decade, what comes to mind? How has the business changed in that time and what reflections can you share?
It has been an eventful decade for both our own business and the markets at large, but the first thing that comes to mind is the maturation and “institutionalization” of outsourced trading – its broad adoption by the industry. Everywhere you look, there is evidence of this dynamic. The buy side is facing continued cost pressures in the form of growing technology costs and ever-increasing regulation, causing managers to take a hard look at their expenses. This has led to widespread exploration of ways to trade more efficiently, and it’s one of the reasons for the rapid adoption of outsourced trading. There are now a large number of players in the space – independent players, sell-side entities, custodians – as well as a variety of business models, including an approach we pioneered called “supplemental trading” – helping managers who have their own traders and/or teams expand their reach, improve workflow and reduce risk and costs.
In a similar way, there is now greater diversity in terms of the kinds of managers who are outsourcing. Historically, outsourced trading was targeted at hedge fund managers at launch and almost exclusively in the U.S.; now clients run the gamut in terms of AUM and domicile. In fact, two of our most gratifying moments from the past decade were the openings of our London and Sydney offices, as they represent the truly global phenomenon that outsourced trading has become. Of course, this rapid growth means that the space has become more complex at the same rate, and managers must ensure they are engaging with providers and doing their due diligence to identify the solutions that best meet their needs.
In 2020 you faced the same challenges we all did, and helped clients cope as well. At the same time, you received a majority investment from Copley Equity Partners in May. How do you assess the year overall and how is business?
The past year has brought together two strong forces that have validated our model in ways no one really anticipated. First, the technological and regulatory forces described above have created an environment in which outsourced and supplemental trading have become a logical solution for increasing access to the sell side while decreasing costs. Second, the volatility introduced by the coronavirus pandemic spurred many buy-side firms to become more active and recalibrate their strategies. This has not changed the overall outlook of the space — we’ve been experiencing between 50 and 100% growth for the past four years – but it has undeniably created tailwinds.
More than six months since our closing with Copley, we are pleased to report that the relationship is operating as the mutually beneficial partnership we had envisioned. Copley’s willingness to move ahead with the deal amid the pandemic is a credit to both organizations – to Copley for their foresight, and to us for the confidence our team was able to inspire.
Tell us more about what that growth looks like. Are you seeing increased interest from one type of client in particular? Are new clients citing a common reason for their engagement?
It has been diverse. Supplemental trading remains the fastest-growing part of our business due to the simple fact that the total addressable market will always contain more established buy-side firms than new launches. But we also saw significant demand for our fully outsourced solution. We added more new clients in 2020 than any year prior, all while a significant number of existing clients began to lean on us more heavily than before. Many of these firms engaged us at the height of volatility in response to specific challenges around access to the sell side, trading in offshore markets, trading difficult-to-move names and maintaining anonymity, among others. Our vast experience and deep relationships with the sell side inform everything we do, and that expertise loomed large as liquidity became difficult to find.
When it comes to outsourced trading, there are numerous providers, many of which employ different business models. How should buy-side firms go about evaluating their options?
It’s important to establish that buy-side firms have a responsibility to educate themselves about the various business models for outsourced and supplemental trading that exist today, and the providers behind them. This is no afterthought – outsourced trading solutions that appear the same may look very different under the hood, with different structures and offering different operational efficiencies. Managers owe it to their investors to identify which make the most sense.
As mentioned, there are a number of different models – independent, sell-side, custodial. It might be useful to ask the question: do you want a single sell-side broker or custodian to represent all of your trading needs, or do you want someone seen by the market as a large buy-side firm? If the former, well, that option has always been available. Furthermore, there are considerations around best execution. The entire TCA industry has been built to ensure that managers are getting the best prices for their investors, so to engage a third party for your trading operations is no small decision – one cannot simply treat it as an operational workflow solution. Finally, as we continue to win business from larger buy-side firms, we are hearing that that execution quality and a conflict-free governance structure were major factors in their evaluation process. If current trends hold, these considerations will take on increasing importance as more of these players turn to outsourced trading.
Ultimately, we expect that as the industry grows, thoughtful fund managers and certainly larger AUM firms will peel back the onion on how outsourced trading providers operate, and pure-play, best of breed solutions will thrive. For those interested in learning more, we have provided a checklist for evaluating providers which you can request from us directly.
You mentioned operational efficiency – what sort of efficiencies are you referring to? What tools and/or technology does Tourmaline leverage to enable these efficiencies?
One of the first that comes to mind is the ability to clear and settle trades in a centralized way. Over the years, the average manager has cut its broker list, a move that lowers administrative costs but hampers the ability to find liquidity. By leveraging our solutions, buy-side firms can expand their reach seamlessly because they only need to face one counterparty: us. Our clients don’t need to manage trade breaks that may stem from using dozens of brokers with whom they may trade opportunistically – we handle the entire process, incorporating all underlying executing brokers. This is bolstered by our continuous investment in technology and human capital. Our global team follows the sun in each region, an especially important consideration for those trading in offshore markets. In addition, we offer a proprietary system that customizes the reporting for all of our underlying clients. Fundamentally, ours is still a service business and this is where many brokers fall down. We approach these operational issues meticulously and the efficiencies are passed along to our clients.
Sourcing and paying for research has evolved into a convoluted process. Tourmaline offers a solution in this area – can you describe it? How does it benefit clients?
We are seeing a greater fragmentation of research around the world. Data and analytics are playing an increasingly large role, and in turn there will be an increasing amount of information originating from non-broker-dealers. Traditionally, this sort of information has been paid for via commissions – trading is the coin of the realm – and as long as our clients adhere to this model, the ability to provide tools to help them manage their commission wallets will be paramount. We offer a comprehensive, centralized commission management solution that enables clients to credit their CCA/CSA account when trading directly with us or with the executing brokers of their choice, while aggregating commissions in a single, centralized account. Our overall approach is defined by a commitment to providing industry-leading tools, systems, reporting, regulatory expertise and service.
This year will see the rise of new leadership at many of the regulatory bodies that oversee the financial services industry. What advice do you have for the new regulators in Washington?
We designed our firm to be client-centric, so we are big supporters of any policy that promotes transparency, good corporate governance and solutions that will benefit end-asset owners. We would like to see regulators promote policies to support competition, best practices and a vibrant research marketplace in the U.S., which is important not only for institutional investors but for capital structure generally as well. As for specific issues, OMS/FIX network connectivity fees are the last component of execution that is not transparent to asset managers and their clients. The community has spent so much time and effort to communicate best execution to the client, and this is the final leg of the journey. If full transparency is the goal, then perhaps regulators should turn their attention to this issue.