Subscribe to Asset Servicing & Fintech Insights
Choosing the Outsourced Trading Model That’s Right for You
How does an asset manager know which outsourced trading model is best for them? Start by considering your ideal future state.
Head of Integrated Trading Solutions, Americas
Recent trends in financial markets - including the impact from the pandemic, shrinking margins, expanding use of performance-based fees, and increasing regulation - have triggered the need for capital light, variable cost operating models. The ability to leverage another company’s assets and expertise not only provides margin flexibility in the face of volatility, but also offers business agility and scale as change accelerates.
Outsourced trading has gained traction not just because it helps reduce costs and increase efficiency, but also because it enhances expertise, scale, and capability. In other words, outsourcing is no longer recessionary but “future state”.
Outsourced trading is not a one-size-fits-all decision. There are different models that asset managers and hedge funds can implement. These include:
- Full outsourcing,
- Component outsourcing, and
- Complementary outsourcing.
Component and complementary outsourcing are commonly referred to as hybrid, as the asset manager retains traders in-house.
How does an asset manager know which is the best model for them? When making a decision, start by considering your ideal future state. If you had a blank slate, how would you prefer to operate? From there, you can work backwards to find the right outsourcing solution and partner.
With full outsourcing, the asset manager does not conduct trading internally, instead fully leveraging an outsourced provider. While this outsourcing approach is used extensively by start-up asset managers or new fund launches, it is also being adopted by larger, more established asset managers. Full outsourcing offers the greatest benefits because it transforms the operating model to one that is highly efficient, scalable, and combinable with services such as trade settlement oversight and foreign exchange execution.
There are multiple benefits to full outsourcing beyond cost reduction. Because full outsourcing can be readily combined with other services, such as middle and back office outsourcing, this approach significantly increases efficiencies. The asset manager also benefits from enhanced trading capabilities as the outsourced provider has more leverage and resource to execute trades, owing to more trading volume, larger investment in trading capabilities, and specialization. And asset managers that choose to fully outsource are able to redeploy trading staff in other value-added roles. For example, the head of trading may serve as head of trading oversight.
With component outsourcing, the asset manager elects to outsource only certain types of trading (i.e. one component of their investment mandate) but does so completely. An example of a component relationship is a US-based equity manager that outsources trading in another global region but retains traders for the Americas. Another example is an income fund manager outsourcing bond trading, but retaining equity trading in-house. An asset manager no longer needs to staff a trading desk for every region and market in which they invest. Component outsourcing can provide many of the same benefits as full outsourcing and allows asset managers to retain a trading function.
In a complementary model, the asset manager utilizes an outsourced trading desk to augment, or complement, their capacity and capability. In this model, the asset manager retains traders in each region and asset class in which they invest, but instead of staffing for their peak volume days, they staff for average days and outsource on higher volume days. While this model doesn’t offer the same efficiencies as the full or component models because few, if any, add-on services other than basic execution are included, complementary outsourcing can reduce the overhead of the asset manager
How do you know which model is the right one? In each, expertise, cultural fit, people, and customization around specific needs are critical.
In the full and component outsourcing models, selecting the right provider matters the most, since you will rely heavily on the outsourced trading desk in these situations. The main consideration is the stability of the outsourcing provider. What is their ownership structure and how stable is the ownership? How much capital and insurance do they carry? How robust is their business continuity model?
A second consideration is alignment of interests and the potential for conflicts of interest. Does the provider trade on a principal basis or for proprietary accounts? Do they own execution venues that might be prioritized over others? How do they prevent information leakage? And, ultimately, how do they manage potential conflicts of interest?
Another consideration is expertise in managing the conversion to an outsourced model. A successful track record of transitioning to outsourced trading has increased significance in a full or component model.
One final consideration is communication. In any outsourcing application, communication is important. In a hybrid model, where the asset manager is spreading trade flow between internal and external trading desks, the interaction between the in-house and outsourced traders must be especially crisp.
Head of Client Solutions, Capital Markets, Americas
The stigma of outsourced trading is being challenged. Firms that outsource are experiencing increased benefits in their search for alpha.
As margin pressures mount, institutional investors are reviewing their operating models, with a focus on front office operations.
Confidentiality Notice: This communication is confidential, may be privileged, and is meant only for the intended recipient. If you are not the intended recipient, please notify the sender as soon as possible. All materials contained in this presentation, including the description of Northern Trust, its systems, processes and pricing methodology, are proprietary information of Northern Trust. In consideration of acceptance of these materials, the recipient agrees that it will keep all such materials strictly confidential and that it will not, without the prior written consent of Northern Trust, distribute such materials or any part thereof to any person outside the recipient’s organization or to any individual within the recipient’s organization who is not directly involved in reviewing this presentation, unless required to do so by applicable law. If the recipient is a consultant acting on behalf of a third party client, the recipient may share such materials with its client if it includes a copy of these restrictions with such materials. In such event, the client agrees to comply with these restrictions in consideration of its accepting such materials.
© 2022 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability as an Illinois corporation under number 0014019. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. This material is directed to professional clients only and is not intended for retail clients. For Asia-Pacific markets, it is directed to expert, institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. For legal and regulatory information about our offices and legal entities, visit northerntrust.com/disclosures. The views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group or individual. The following information is provided to comply with local disclosure requirements: The Northern Trust Company, London Branch, Northern Trust Global Investments Limited, Northern Trust Securities LLP and Northern Trust Investor Services Limited, 50 Bank Street, London E14 5NT. Northern Trust Global Services SE, 10 rue du Château d’Eau, L-3364 Leudelange, Grand-Duché de Luxembourg, incorporated with limited liability in Luxembourg at the RCS under number B232281; authorised by the ECB and subject to the prudential supervision of the ECB and the CSSF; Northern Trust Global Services SE UK Branch, UK establishment number BR023423 and UK office at 50 Bank Street, London E14 5NT; Northern Trust Global Services SE Sweden Bankfilial, Ingmar Bergmans gata 4, 1st Floor, 114 34 Stockholm, Sweden, registered with the Swedish Companies Registration Office (Sw. Bolagsverket) with registration number 516405-3786 and the Swedish Financial Supervisory Authority (Sw. Finansinspektionen) with institution number 11654; Northern Trust Global Services SE Netherlands Branch, Viñoly 7th floor, Claude Debussylaan 18 A, 1082 MD Amsterdam; Northern Trust Global Services SE Abu Dhabi Branch, registration Number 000000519 licenced by ADGM under FSRA #160018; Northern Trust Global Services SE Norway Branch, org. no. 925 952 567 (Foretaksregisteret) [VAT if applicable], address Third Floor, Haakon VIIs gate 6 0161 Oslo, is a Norwegian branch of Northern Trust Global Services SE supervised by Finanstilsynet. Northern Trust Global Services SE Leudelange, Luxembourg, Zweigniederlassung Basel is a branch of Northern Trust Global Services SE. The Branch has its registered office at Grosspeter Tower, Grosspeteranlage 29, 4052 Basel, Switzerland, and is authorised and regulated by the Swiss Financial Market Supervisory Authority FINMA. The Northern Trust Company Saudi Arabia, PO Box 7508, Level 20, Kingdom Tower, Al Urubah Road, Olaya District, Riyadh, Kingdom of Saudi Arabia 11214-9597, a Saudi Joint Stock Company – capital 52 million SAR. Regulated and Authorised by the Capital Market Authority License #12163-26 CR 1010366439. Northern Trust (Guernsey) Limited (2651)/Northern Trust Fiduciary Services (Guernsey) Limited (29806)/Northern Trust International Fund Administration Services (Guernsey) Limited (15532) are licensed by the Guernsey Financial Services Commission. Registered Office: Trafalgar Court, Les Banques, St Peter Port, Guernsey GY1 3DA. Northern Trust International Fund Administration Services (Ireland) Limited (160579)/Northern Trust Fiduciary Services (Ireland) Limited (161386), Registered Office: Georges Court, 54-62 Townsend Street, Dublin 2, D02 R156, Ireland.