Outsourced trading is breaking down barriers for buy-side desks

To access bigger and broader sets of tools and markets, tier one asset managers are leveraging outsourced trading to supercharge their inhouse capabilities.

Outsourced trading is being used to boost the ability of buy-side firms to deliver best execution across an increasing range of situations. At a point where fee compression and the macro environment are putting pressure on investment performance, finding a path to scale up investment operations must be based upon flexible supply and demand, rather than fixed costs and resources.

“Scale should be one of the primary benefits that an outsourcing provider can bring to a client and it’s often overlooked in favour of cost,” says Mark Goodman, head of UBS Execution Hub and Platforms. “The benefit a client derives by partnering with a trading firm that has a greater magnitude of operation, is many tiered. There are economies of scale through delivering trading. At the same time an outsourcing provider can bring the right skills, asset class or geographical coverage at the right time to deliver support.”

Market events which trigger the need for outsourcing can be both positive, such as the launch of successful new investment products, or negative, such as rising trader turnover. While the appetite to outsource may have historically sat with the chief investment officer (CIO) as a binary choice between an internal or external trading operation, the heads of trading within buy-side firms are now engaging with suppliers to provide complimentary resource to their inhouse team.

“The classical discussion around outsourced trading is with CIOs looking at the bigger picture and thinking about alternative ways to manage trading. Smaller AUM firms were the historical starting point to outsource trading, because providers set up exclusively to address the provision of outsource trading to match their scale,” says Goodman. “The arrival of more established, larger providers has created the scale and breadth of services needed to support larger clients with greater demands.”

The broader offering available today has allowed a wider set of buy-side firms to engage with outsourcing providers. As the client base has matured, the number of user cases has widened.

Examples of this include the supply of traders to cover new geographies, and to manage trading in an expanded set of assets or instruments. For many asset managers this can be used to reflect a difficult economic environment, in which the search for yield in a zero-rate market has rapidly changed into a market struggling to manage rising inflation.

This is illustrated by emerging markets funds, which have seen a record period of monthly outflows in July, according to the Institute of International Finance, following a period of positive investor sentiment in 2021 and early 2022. Management of resources to support this rollercoaster investment landscape is very challenging.

Not only are the traders needed to build and handle positions, the diverse time zones, market structures and broker pools that exist in the emerging market space lend themselves to a complex, fragmented landscape that takes time and skill to manage effectively.

If the buy-side firm can focus its in-house trading desk to optimise execution performance around core markets or asset classes, and outsource the management of their orders in another region or another asset class, that offers a very good way to quickly scale up global reach. In this model, the inhouse trading desk is not replaced but given a tighter focus. This can also support complex, value-added trading.

We are talking to a buy-side firm who is running a global, liquid equity long-short strategy, and a risk premium strategy using complex options,” notes Goodman. “They’re looking to focus the in-house desk on the complex options trading and outsource more utility equity flow to focus resources where they can add value.”

A further model is the supply of overflow trading by co-sourcing, in some cases this might be to handle critical, natural peaks, such as the month or quarter end, or business continuity planning.

“A large established firm has the bench to support trading capacity at a much higher level,” notes Goodman. “It’s the scale of the team and of the broker network. If you need to service a large number of diverse clients, you need a large and diverse broker network and that brings liquidity access and information.”

The necessary investment in technology is an easily overlooked aspect which has a constant impact on operational costs and performance if not global reach. That should be a key element of an outsourced offering, as it set limits on the expansiveness of an agreement.

That is also true for licensing and regulatory approval. Where a provider does not have to subcontract out to other local firms, because it already has an established operation, it has greater speed and depth of supply to its clients.

“When we wanted to set up in Singapore it was relatively straightforward; we had premises, we had a banking licence, we had second-line control functions, desks and PCs and everything you need,” Goodman notes. “It’s exemplary of the speed we can achieve in providing global range – we have been global since day one. It also shows the scale of experience. The breadth of instruments and situations developed from managing multiple mandates is very advantageous to clients.”

Benchmarking the value of an outsourced arrangement also moves beyond cost. The stakeholders need to be engaged and to provide input on the quantitative and qualitative value that the trading function provides. For more quantitative assessment of execution quality, both provider and asset manager need to ensure they can pool and aggregate data to assess trading capabilities and capacity.

“When we’re bringing clients on, we make sure we engage with them and encourage them to put measures in place because that helps us be a better partner,” he adds. “On the quantitative value side, our mantra is all of the trading benefits with none of the overheads. On a more qualitative level, we need to function as an extension of the buy-side desk to the point where they should forget they’ve outsourced.”