Once just the purview of hedge-fund startups, it’s increasingly viable for mid-sized asset managers.
Events this year have highlighted the continued growth of outsourced trading as the buy side has been faced with increased volatility and volumes at the same time as downward pressure on fees and increased regulatory requirements around best execution which require investments in data and technology infrastructure.
Quentin Limouzi, global head of order and execution management & equity trading solutions at London Stock Exchange Group, told Markets Media that it was clear that outsourced trading is gaining traction, which was accelerated by the COVID-19 pandemic as traders worked from home and volatility spiked.
“Human capital is hard to find and expensive, and in an environment where you don’t know what the volatility is going to be, it’s easier for funds to outsource their trading and pay for what they need, rather than pay high fixed costs,” Limouzi added. “The overarching theme for a long time has also been the increase in best execution mandates.”
Outsourced trading offering can help reduce spending on data, trading infrastructure, analytics and reporting required to meet these expanded regulatory mandates. As markets remain volatile, outsourced trading also gives the buy side the flexibility to expand into new asset classes and regions quickly and efficiently, as well as offer 24-hour global trading capabilities without the human and technology costs and operational risk of having an in-house, round-the-clock desk.
Limouzi noted that historically, outsourced trading has been more prevalent with hedge funds – especially with smaller funds and new launches – than with long-only investment managers. Anecdotal industry estimates suggest that about half of newly launched hedge funds outsource trading. “That makes sense because when you start up a fund, you’re starting your investment profile and you need to have your operational ducks in a row,” Limouzi said. “You’re not chasing trading alpha right away, you’re chasing investment performance so you can scale up.”
The pandemic starting in 2020 has expanded the customer base for outsourced trading, to an estimated foothold of 20% among mid-sized asset managers. “In the past, everybody had to be on the desk, but COVID inspired remote work,” Limouzi said. “Portfolio managers have become more comfortable working with traders over Teams and other communications platforms. That’s opened the door to outsourced trading.”
And there’s the challenge of staffing. “It is not just hard to find good talent, because there is a lot of competition, but it is also hard to find the right talent with the right experience,” added Limouzi. “The needs of a money manager can shift rapidly from one strategy to another, and being able to pick someone who knows a market and asset class very well and just drop them on a desk is really important.”
The experienced staff employed in outsourced trading firms also means they are likely to have a more established network for sourcing liquidity and portfolio-specific market intelligence , which will help achieve best execution. As a result, the buy side has become increasingly comfortable with the outsourced trading mode and the number of outsourced trading providers increased from nine in 2018 to more than 40 in 2022, according to consultancy Coalition Greenwich.
From Niche to Mainstay
“Outsourced trading has grown from something of a niche offering in the market to one of its mainstays,” Coalition Greenwich stated in a July 2022 report. “Moreover, as large firms (as well as small) continue to expand their use of supplemental trading with outsourced firms, there will be an ongoing institutionalization of the space, providing more avenues and opportunities for expansion.”
From a demand perspective, CRUX Asset Management CEO Karen Zachary told GlobalTrading in 2020 that outsourced trading helped the firm – which had £1.7bn of assets — manage costs and operational risk. “Outsourcing of trade execution has worked well for CRUX, particularly as a smaller business looking to minimise fixed overheads such as technology, data and personnel costs,” Zachary said. “With the appropriate oversight and controls in place I believe there to be limited downside to outsourcing but it is important that the fund managers know their team at the provider… I see that more larger institutional managers are reviewing their operating models and considering the move towards a greater level of outsourcing.”
Zachary stressed the importance of fund managers having strong relationships with the outsourced-trading provider, and neither side becoming complacent about the arrangement.
LSEG expanded its outsourced trading product suite when it acquired TORA in 2022. Limouzi said TORA, a cloud-based technology provider supporting customers trading multiple asset classes across global markets, has been a significant driver in providing increased geographical coverage.
“Overnight trading and the regional expertise in idiosyncrasies that you see across market structure as well as familiarity with brokers and counterparties are really important,” he added. “We see outbound U.S. to Asia, and Asia to U.S, getting really busy and that is where we can really step in.”
LSEG provides multi-asset class coverage, globally, 24/6 and covers the entire order lifecycle from origination through to reconciliation. LSEG’s outsourced model is unique versus its peers as it provides a value add on top of the technology platform to enhance the client experience via its TORA offering.
TORA operates as a buy-side trading desk established within a technology firm. As a broker-agnostic service provider, its objective – to provide better tools and implement them without friction — is aligned with those of its clients, spanning trading, technology and analytics.
“One of the hardest things for outsourced trading firms is to implement all the technology their clients are using,” he added. “The fund manager uses TORA for trading, and our traders use TORA, which really helps the process.”
With its development resources and experienced support team, LSEG can handle the complex implementations that are common among larger firms, as well as integrate with other technology platforms more easily than competitors who are reliant on third-party systems.
Limouzi expects outsourced trading to continue to grow, especially as electronic trading expands across asset classes, such as fixed income, and buy-side trading desks increasingly become multi-asset class. He said: “Cost and flexibility are always going to be focuses, especially for small to mid-size investment managers.”
The opinions expressed are those of the author(s) and do not necessarily reflect the views of LSEG, its clients, or any of LSEG’s respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
