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Challenging the Stigmas of Outsourced Trading

The stigma of outsourced trading is being challenged. Firms that outsource are experiencing increased benefits in their search for alpha.

Outsourced trading has turned mainstream over the past few years, starting as a niche service but now being adopted by asset managers of all varieties and sizes.  Despite the growing popularity, outsourcing is sometimes perceived as a recessionary business, more about cost savings or for asset managers that are smaller in scale.  Like other outsourcing trends, however, that stigma has been disproven over time. Asset managers that have moved to outsourced trading have experienced the realities of efficiency, flexibility, and transparency in their search for greater alpha.

Misconception: It is all about saving money.

Reality: Substantial savings can be realized when outsourcing, but the additional scale, business resiliency, expertise, and added services that come with outsourced trading are just as important.

By choosing to outsource a non-core function, asset managers can position their business for future growth by future proofing operations, streamlining efficiencies and enhancing returns. Additional services can be seamlessly integrated as well, including settlement oversight, automatic currency conversion to base currency, trade cost analytics, and commission management.  While outsourced trading can address the need for immediate and material cost savings, it comes with the potential to position firms for a more optimal, future state. Looked at in these terms, it can be presented as a positive, showing firms are focused on the future and looking forward to growth.

Misconception: If we outsource trading, we’ll be an industry outlier.

Reality: The trend toward outsourced trading continues to grow.

In Q1 of 2024, WBR Insights and Northern Trust surveyed 300 CEOs, CIOs, Directors of Operations and similar from across APAC, EMEA and North America regions, from asset management with an AUM of $500bn and below. The survey sought to understand how managers are prioritizing their strategies in the next two years, and how those may have evolved to adapt to the changing market environment. When asked about outsourcing, 74% of respondents said the cost of maintaining in-house capabilities has increased their likelihood of outsourcing. Furthermore, 30% of those respondents said they have considered outsourcing their trading in the next two years.

Misconception: It is only for small or start-up asset management firms.

Reality: Outsourced trading makes economic sense for small or start-up asset managers, but the efficiencies and leverage extend to well established firms as well.

Change is happening in the asset management industry faster than ever. Passive management and ETFs are ubiquitous. The younger generations have eschewed traditional investment advisor relationships and mutual funds. Regulation is rapidly evolving. Furthermore, the global pandemic has proven that portfolio managers and traders do not need to be physically co-located. As a consequence, asset managers of all sizes are re-thinking their current business operation with eye to find an optimal future state. As part of this process, the trading desk is under scrutiny: Is the trading desk critical in adding alpha? Does this function help us raise capital? Are the trading desks fully utilized? For many, it’s become hard to say that in-house trading desks are essential, and even harder to evidence any contribution to generating alpha. These firms are turning to the hyper-scale asset servicers which often perform these activities better than if they were kept in-house. Trading is a scale business, and the question is increasingly one of what’s likely to produce the best outcome.

Misconception: People will lose their jobs.

Reality: While many asset managers conclude they get little value from the activity of trading, they often find they still get value from the people performing those activities, the dealers themselves.

In this sense, talent is not being displaced, it is being re-tooled. For example, the head of trading might find their role is redundant, but then find themselves in another role, as head of trading oversight. For whom better to have in that role but someone who knows it intimately? We believe this will be seen positively by regulators from a control perspective, and by asset managers and asset owners from a risk perspective and profit and loss perspective.

Misconception: There is a loss of relationships and connectivity.

Reality: One plus two equals three. That is to say that the current relationships and trading volume of the asset manager, when combined with the larger set of relationships and trading volume of the outsourced trading provider, actually increase and enhance relationships and connectivity.

Some asset managers may fear that the years spent building relationships, know-how and expertise when trading in particular markets or instruments could be lost, which in turn might negatively impact client outcomes. Many outsourcing providers are sensitive to this and work hard to show clients that far from displacing this connectivity, they augment and often enhance their relationship to the street. This is achieved by clients leveraging global teams of highly experienced traders, many with buy-side experience, and with a broad array of relationships already well established. Added comfort comes from Trade Cost Analysis (“TCA”) that can measure trading performance.

Misconception: There is a risk of internal competition.

Reality: Internal competition happens daily for every broker-dealer, often without the buy-side trade or portfolio manager even knowing about it. When outsourcing, the asset manager will have better insight and control in the rare situation where two market participants are on the same side of a trade at the same time with the same instructions.

In a non-outsourced model, when a market participant is selling something at the same time and same pace as another, the orders are unknowingly competing and creating excessive pressure on the stock price. The outsourced trader can better manage collective orders, splitting fills and managing overall market impact appropriately to avoid disrupting supply and demand in the marketplace. TCA reporting and regular governance meetings with the outsourced trader can also provide transparency and an effective feedback loop on trade management.

Misconception: There is an increased chance for information leakage.

Reality: Outsourced trading actually helps disintermediate information to the street.

When an asset manager conducts their own trades, their activity is easier to decipher. Any time an asset manager presents a large buy or sell order to a broker-dealer, a signal is presented directly to the street that the asset manager is building or exiting a position. And broker-dealers will often reference regulatory filings, such as 13F reports in the U.S., to identify larger portfolio shifts. In an outsourced trading model, orders are mixed in with all other orders, thus no one on the street has any idea for whom the trades are being made. In addition, an outsourced trader can help disintermediate order flow. Finally, outsourced traders can provide TCA reports that provide price performance before, during, and after a trade is completed to constantly evaluate and look for the potential of information leakage.

Misconception: The transition will be disruptive.

Reality: With the right transition plan, the shift to an outsourced trading model is very manageable.

An outsourced trading relationship must work in the long-term and a good provider provides an implementation process to fully support clients as they make the transition. The implementation should begin with a detailed discovery phase to fully understand the current trading touchpoints across all areas of the asset management firm - from the investment decision, compliance and risk, trade routing, reporting, and settlement. The outsourced trading providers should design an optimal future state and the service components for the relationship. This can help provide a seamless transition from a legacy desk to an outsourced trading provider and help ensure that there is no disruption to the client's investment process as a result.

Misconception: Our clients will fire us if we outsource trading.

Reality: This does not appear to be happening.

Asset allocators and investment consultants are focused first and foremost on risk adjusted returns and fees. A strong case can be made that outsourced trading improves returns through greater scale and deeper expertise, reduced fees, and greater operating efficiencies. The benefits of outsourcing are significant, and investors recognize the value that results from improved technology, better governance, and heightened operational resilience.

The Reality of Outsourced Trading

Old assumptions about outsourcing have been challenged and, particularly during the pandemic, proven incorrect – a key example being the perceived need for proximity between portfolio manager and trader that work from home protocols have discredited. More widely, where outsourced trading had been seen as a defensive, reactive strategy, focus has now shifted to the variety of other benefits offered – including supporting risk management, streamlining operations, enhancing governance and improving operational and technological resiliency. Outsourced trading is increasingly a proactive and future focused decision and, as a result, many asset managers view it as a better way of doing things.

Grant Johnsey portrait

Grant Johnsey

Head of Client Solutions, Banking & Markets, Americas
Grant is responsible for delivering capital market solutions to institutional clients across agency brokerage, transition management, security finance, and foreign exchange.


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