Outsourced trading is the latest hot topic, but what does it really mean? To some, it is a strategic extension of their current trading capabilities, while others use outsourced trading to minimize overhead costs as they expand their assets under management (AUM). In addition to trading, some want to outsource their middle office and back office functions. In all cases, outsourced trading should be customized to meet the needs of each investment manager.
As a strategic extension of an existing desk, outsourced trading can provide experienced traders in all major market segments:
- Equities
- 24-hour access to global markets
- FIX connectivity to all major liquidity sources
- ETF creation and redemption via multiple AP relationships
- Fixed Income
- Access to substantial list of counterparties, including primary and regional dealers
- Derivatives
- Options
- Futures
As a cost-management strategy, outsourced trading can reduce expenses associated with maintaining a fully-staffed trading desk:
- Eliminates system costs such as order management, FIX connections, and Alert/Oasis
- Retains back-up trading capabilities when employees are on vacation or taking paid time off
- Allows portfolio managers to focus on stock selection and client acquisition
- Allows trading for new products (e.g. international to be outsourced until critical mass AUM is reached)
Trading desks are expensive. Some buy-side firms make large investments in software, hardware and personnel who understand the new market structure and how to access liquidity and avoid toxic venues to gain an edge. Others would like to but cannot afford it.
The trend for buy-side trading desks seems to be headed in one of two directions. One path is investing in leading-edge tools and relying less on the sell-side for high-touch services to implement their strategies. Larger firms with scale and fee revenue can afford to maintain increasingly sophisticated trading desks. The other path is outsourcing all or part of trading desk functions. Smaller firms are desperate to keep up but lack the scale and suffer from the same escalating costs coupled with fee and commission rate pressure. It makes sense for the small- and medium-sized firms to outsource the expensive technology and know-how to a trusted sell-side partner while directing resources to internal research and innovation.
What does a trusted sell-side partner look like? While some buy-siders would say that is an oxymoron, here are the key questions:
- Trading Experience & Market Access
- Does every trader have the experience necessary to handle complex orders?
- Do they have access to all major liquidity venues?
- Do they offer all assets classes? Global equities, fixed income, options and futures?
- Can the client access trading systems and algorithms directly?
- Organizational Structure
- Structural conflicts: Do they act as agent or have principal trading accounts?
- Are all revenue sources clearly defined? Is crossing stock a major revenue source?
- Do they offer multiple pricing models, i.e. percent of commissions, cps on every order and/or subscription?
- Is FINRA BrokerCheck devoid of regulatory issues?
- Do they take payment for order flow or offer price improvement where possible?
- Are disaster recovery and backup systems state-of-the-art?
- Capabilities
- Can they face the street to pay other brokers and procure proprietary research with attribution to the manager?
- Can the broker provide real-time trade cost or venue analysis?
- Can they provide compliance and regulatory support for client commission arrangements (CSAs)?
- Can the broker support middle- and back-office functions and reporting?
No two managers needs are identical. An outsourcing partner must to be able to tailor a solution to each managers unique situation and adapt as the clients needs change. At CAPIS, we strive to understand each client and to develop the ideal outsourcing solution.
Christopher J. Hurley is Senior Vice President, Director of Institutional Sales at CAPIS
