Skip to content

Subscribe to Asset Servicing & Fintech Insights

Discover more information in our monthly publication, the AXIS newsletter, including industry trends, product innovation, Fintech and more from our team of experts.

More Is More in Outsourced Trading

Well beyond cost efficiency, expertise and scale help create performance advantages for asset managers who work with external trading desks.

As seen in Institutional Investor.

The latest trend in outsourced trading might just be a shift in perception. Like many asset managers, Westwood Holding Group first viewed outsourced trading purely as an efficiency play. After a short time, portfolio managers at the boutique firm with more than $14.5 billion in AUM (as of March 31, 2021) realized outsourced trading was a performance game changer for them, as well.

"Just like everyone else in our industry, we’re under a lot of pressure to streamline costs while still delivering high value services to our clients,” says Westwood COO Fabian Gomez. “Outsourced trading allowed us to reduce the costs of the staffing and equipping a buy-side trading desk, which is very expensive. As we did our due diligence, however, we began to see new benefits we could provide to our clients, including being able to trade in securities that we didn’t necessarily have expertise in.”

Wide-ranging expertise available through scale

A well-constructed trading desk is an inefficient endeavor for an asset manager to undertake. The depth of coverage, expertise, and flexibility required to hit the ground running on the busiest and most volatile days is staggering, and that doesn’t cover clients who might have unusual requests involving far-flung markets, or the ever-present potential for employee absence and turnover.

“Trading is a scale business,” says Grant Johnsey, Head of Integrated Trading Solutions, Americas, at Northern Trust. In his role, Johnsey oversees integrated trading solutions that give clients the ability to scale for both size of team and expertise on a daily basis.

“We have a large trading desk stacked with wide-ranging expertise that clients can tap into, whether it’s block or program trading, and expertise in local markets for the Americas, EMEA, and APAC,” says Johnsey. “Between our team and the expertise throughout Northern Trust, we can answer almost any question. We have traders in New York, Chicago, London, and Sydney. I can leverage the broader experience and expertise of Northern Trust to get answers beyond the normal range of what an asset manager typically has access to internally. The advantages of scale even go beyond that, however. When you consider we have 65 clients on our outsourced trading platform, about 1,200 institutional asset owners we do brokerage for, and more than 100 family offices, that’s a lot of touchpoints that can help provide answers and context for any one client.”

To illustrate how flexible scale and expertise benefit institutional clients, Johnsey cites an example of a client who outsourced trading to Northern Trust. The client no longer has a trading desk, and recently had two portfolio managers rebalance and a client give the firm new inflow – all on the same day. Were it not for outsourcing, the client told Johnsey, it would have been challenging to efficiently service all the portfolio changes in that scenario. Instead, the situation was handled without missing a beat.

Dispelling misperceptions

Many current-day portfolio managers are accustomed to having the buy-side trading desk close at hand. It hasn’t always been that way. Johnsey notes that buy-side trading desks are a relatively recent development in the investment world, proliferating in the 1990s because markets were extremely inefficient before electronification, and because the desks created a sense of protection against sometimes questionable behavior on the part of sell-side brokers.

“To the extent that portfolio managers still felt as if they needed the buy-side traders nearby, that has been proven unnecessary by the COVID-19 pandemic,” says Johnsey. “Not only is having traders within sight no longer a necessity, but the efficiencies of outsourcing have become more obvious. Firms that outsource their trading function are better able to manage volume spikes, have access to advanced technology, and can better manage their risk and governance thanks to the expertise, scale, and capability of their outsourced trading partners.”

To Johnsey’s eye, the volatility and market movements seen in March and early April 2020 were more extreme than in the global financial crisis or the dotcom blowup of the early 2000s.

“I haven’t spoken to a single asset manager that had traders and PMs physically working side-by-side during the early days of the pandemic – and they all survived. That pretty much blew up the myth that traders need to be within the four walls of an organization,” he says.

The pandemic also underscored an idea the SEC has been pushing for some time now, namely that asset managers should be more resilient to disruption. With the exception of the largest asset managers, most don’t have offices around the world, nor do they have particularly deep benches. For the bulk of managers, having a remote working situation thrust upon them by the pandemic allowed them to see that outsourced trading provided another benefit – business continuity.

Along with the perceived need to keep their traders close, another fear among some portfolio managers has also proved to be a canard – that by outsourcing trading they could lose some mandates.

“We haven’t seen a single scenario in which that’s happened,” says Johnsey.

A multi-pronged technology edge

The cost efficiencies that initially created interest in outsourced trading still exist, but they are really table stakes in an investment world where capital-light, variable cost operating models are a must-have for asset managers dealing with margin pressure. The differentiators, then, become things like scalability, as already mentioned, and technology.

For example, those who outsource their trading to Northern Trust gain distinct post-trade benefits from its technology solutions, which also contribute to controlling trading costs.

“We can send the data for a completed trade via SWIFT to all of an asset manager’s custodians, whether separately managed or fund, and then we can oversee the settlement process,” says Johnsey. “That means that the asset manager may no longer need to pay SWIFT fees or for a big bank identifier code. They no longer need to pay for certain trade matching and settlement products, and so on.”

Northern Trust outsourced trading clients also benefit from foreign exchange services through CompleteFX™, which calculates trades back to a base currency and automatically executes at a time designated by the client.

“For example, if a manager has five sells and three buys in Japan, we can net out the Japanese yen and execute those trades,” says Johnsey. “That’s a huge advantage for the manager. It takes the risk off of them, reduces the amount of work, and achieves a better, quicker fill in the FX market when the equity trade is done.”

Trade cost analytics, commission management, and assisted MiFID II reporting are among additional benefits asset managers reap through an outsourced relationship with Northern Trust. Viewed holistically, the scale and technology edges in such a partnership also contribute to more rigorous risk management and compliance. This is most visible in transition management and in the reduction of operational risk, where the FX scenario describe by Johnsey serves as a fine example.

Focus on the “optimal future state”

The decision to outsource trading isn’t one made lightly, and asset managers do tend to lean toward large, stable, and trusted counterparties. This makes sense for many reasons. The bigger the outsourced trading partner, for example, the greater the number and quality of relationships with execution venues. Some managers worry that they might lose access by outsourcing trading, but Johnsey points out that when the access a manager already has is combined with that of Northern Trust’s trading desk it results in more access to be leveraged, not less. In addition, some portfolio managers are remiss to give up the safety blanket of the internal trading desk because they fear how it will look to clients.

“If the best trader in the world has less access, less scale, and less leverage they are not going to be as effective as they would be with more tools and better access,” says Johnsey. “Even if the buy-side firm manages $10 billion and has superb traders, they’re only controlling a small amount of flow, so they’ll never have the same access, coverage, or expertise of a firm with 10 times that flow with 10 times the number of people on the desk. If a firm is seeing demonstrably weaker coverage from the street, providing scale will help solve that. We can get them into any market they want to be in, and they don’t have to ramp up if they open a new fund. It all really helps the manager focus on what they are hired to do in the first place – execute a specific risk-reward investment strategy with competitive fees.”

For Gomez and his colleagues at Westwood, the due diligence process led them to consider Northern Trust.

“We knew that ultimately we were going to have to present this to our consultants and some of the subadvisors who trust us to manage their money,” says Gomez. “We thought those conversations would go much smoother if our final choice was a large, well-known entity that could support us in the long term.”

After meetings with compliance, operations, and the trading desk at Northern Trust and another large bank, Westwood opted to outsource its trading to Northern Trust. According to Gomez, Westwood’s clients and advisors were quite open to the concept once they understood the details. In addition, Westwood’s former head of trading was moved into a director of operations role. After about eight months into the partnership with Northern Trust he surveyed the Westwood’s portfolio managers to see how they felt the outsourced trading relationship was progressing.

“The portfolio managers were very pleased,” says Gomez. “They were probably happiest about the more challenging asset classes for us, like small caps. And our multi-asset team is leveraging more and more of Northern Trust’s fixed-income trading capabilities from a sourcing perspective as well as just pure execution.”

It’s interesting to note that Gomez mentioned long-term support from an outsourced trading partner, because as Johnsey puts it, a major goal for his team is to help clients realize their optimal future state.

“Where are they now, and where do they want to go?” asks Johnsey on behalf of clients and potential clients. “When we know the answer to that, we can create a customized outsourced trading experience in line with their desired future state. The answers vary quite a bit from firm to firm, which is why we don’t offer a standard solution. We work with each of our outsourced trading partners in a dynamic way that’s unique to them.”

Grant Johnsey

Head of Integrated Trading Services (ITS) Americas
Grant Johnsey is Head of Integrated Trading Services (ITS) for the Americas.

  

Related Content

How does an asset manager know which outsourced trading model is best for them? Start by considering your ideal future state.

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.

© 2021 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 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; Northern Trust Global Services SE UK Branch, 50 Bank Street, London E14 5NT; Northern Trust Global Services SE Sweden Bankfilial, Ingmar Bergmans gata 4, 1st Floor, 114 34 Stockholm, Sweden; 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, 3rd Floor, Haakon VII's Gate 6, 0161 Oslo, Norway; Northern Trust Global Services SE, Leudelange, Luxembourg, Zweigniederlassung Basel is a branch of Northern Trust Global Services SE (itself authorised by the ECB and subject to the prudential supervision of the ECB and the CSSF). The Branch has its registered office at Aeschenplatz 6, 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) 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.