Brian Jepsen
We have seen a significant uptake in the use of outsourced trading services by buy-side firms. As its popularity grows, the number of outsourced trading providers has ticked up as the buy side looks for providers who can go beyond pure outsourcing and act within a collaborative ‘co-sourcing’ arrangement.
- There has been an uptick in the use of outsourced trading services by buy-side firms which often gives asset managers and hedge funds access to sophisticated algorithms and advanced order routing technologies which they may not otherwise have.
- A co-sourcing partner works as an extension of the fund’s existing team to help fulfil the client’s objectives leading to a more integrated and seamless approach to trade execution and decision making.
In recent years, there has been a significant uptake in the use of outsourced trading services by buy-side firms, and with good reason. In a recent survey conducted by Coalition Greenwich in association with LSEG[1], 66% of buy-side respondents believed that outsourced desks could provide them with better access to liquidity, and 63% felt they could offer improved execution quality and trade performance.
By outsourcing their trading activities, asset managers and hedge funds can gain access (which they might not otherwise have) to sophisticated trading algorithms and advanced order routing technologies, which can optimise their order execution, minimise market impact and reduce slippage, particularly for large orders.
There are many other advantages. Particularly beneficial to smaller firms or those who don’t have a high volume of trades, is the outsourcer’s ability to achieve economies of scale, potentially leading to lower transaction costs. Other benefits include ‘hands-off’ management of the day-to-day operational aspects of trade execution so that firms can focus on core investment activities; assistance with regulatory compliance, reporting, and other administrative tasks; and the ability for firms to easily scale their trading activity up or down in response to market conditions - or to test out strategies in new markets - without the need for additional in-house resources.
Beyond Outsourcing
As the popularity of outsourced trading has grown, the number of providers has also increased to satisfy the rising demand, leading to an ever more competitive landscape with many offerings. Firms with internal dealing functions are increasingly seeking providers who can add value by going beyond pure outsourcing, to offer a more consultative and collaborative ‘co-sourcing’ arrangement.
A co-sourcing partner works as an extension of the fund's existing team, with regular, in-depth communication to ensure that they fully understand the client’s objectives. This leads to a more integrated and seamless approach to trade execution and decision-making.
On the part of the provider, such an arrangement requires not only state-of-the-art order and execution management technology but also experienced trading teams with deep market knowledge, capable of navigating complex trading environments across multiple asset classes and jurisdictions.
The goal is to provide the client with a customised trading solution that closely aligns with their specific needs, strategies, and risk profile, one which offers the flexibility to adapt quickly to changing market conditions, regulatory environments, and strategic shifts in the investment and trading objectives of their various portfolios.
Analysing the Data
With respect to execution strategy, an important benefit is the provider’s ability to deliver detailed, data-driven insights into the client’s trading activities, along with suggestions and recommendations on how those activities could be optimised. Such insights could include:
- detailed breakdowns of past trades, including timing, execution quality, and comparison against benchmark performance
- insights into slippage and market impact, and how these can be managed
- full and transparent transaction cost analysis, consistent across brokers, trading venues and markets
- analysis of broader market data to identify trends, cycles, or patterns that might affect the trading strategy
- information on the liquidity of the assets in the client’s portfolio and how liquidity varies throughout the trading day, or under different market conditions
- insights into the market, credit, and liquidity risks associated with the client’s trades and overall portfolio
Take for example a situation where ‘hidden’ slippage can erode trading performance. The outsourced trader might be following a client's standing instruction to execute trades a few minutes after market open, ostensibly to avoid opening volatility. While this may align with the client's risk profile, it may not actually be the most optimal way to execute those trades. Evaluating whether this practice actually translates into cost savings without undue risk, something not immediately apparent without in-depth analysis, requires both the appropriate tools and a high level of market structure expertise. The resulting recommendation from the provider could be to trade into the open rather than a few minutes later, thus avoiding the hidden slippage (which the client wasn’t previously aware of) and the associated costs.
Another area where technology really comes into play is around transaction cost analysis (TCA). Typically, fund managers receive TCA reports from their brokers. However, obtaining consistent and comprehensive TCA figures from multiple brokers can pose several challenges. Different brokers may use different methodologies and benchmarks for calculating transaction costs, making it hard to compare data across providers. Not all brokers provide the same level of detail or quality in their TCA reports, which can lead to an incomplete understanding of costs. Aggregating and normalising data from multiple brokers for a comprehensive analysis can be complex and time-consuming. And, last but not least, there might be inherent biases in the TCA provided by brokers, especially if they are analysing their own execution quality.
An independent co-sourcing provider using state-of-the-art TCA tools addresses these challenges by applying a consistent methodology across all trades, regardless of the executing broker. This allows for a standardised and comparable analysis across the client’s entire trading activity, removing the burden of collecting, normalising, analysing and reporting on transaction costs internally, thus allowing the client to focus on its core activities. Again, based upon these deeper insights and sophisticated analysis - including real-time cost analysis, market impact assessment, and benchmarking against peers or industry standards, - the co-sourcer can offer strategic recommendations on how to adjust trading strategies, venues, or timing to optimise transaction costs.
A Collaborative Approach
In conclusion, the emergence of co-sourcing with execution consulting represents a pivotal evolution in the outsourced trading landscape, offering buy-side firms a strategic partnership that aligns with their trading objectives and enhances their operational efficiencies. This collaborative approach not only ensures that clients' trades are executed with precision and expertise but also empowers them with comprehensive, data-driven insights that inform better decision-making. Co-sourcing partners such as LSEG TORA, drawing upon advanced technologies, deep market acumen and a vast universe of real-time market data and analytics, stand as crucial allies to asset managers and hedge funds, enabling them to navigate the complexities of the market with greater agility and informed confidence.
By choosing the right co-sourcing partner, firms are not merely outsourcing tasks, they are engaging in a partnership that can enhance their strategic capabilities, optimise their trading operations, and ultimately, drive their continued success.
Disclaimer: This article is for informational purposes only, is not intended to be and should not be taken as legal or other type of advice. The opinions expressed are those of the author(s) and do not necessarily reflect the views of London Stock Exchange Group plc (“LSEG”), its clients, or any of LSEG's respective affiliates. Tora Trading Services, LLC is registered with the SEC and a member of FINRA, SIPC, NFA. TORA Trading Services Limited is regulated by the HK SFC. Not all TORA services and related services are offered via the regulated entities. In addition, TORA services are not available in all jurisdictions.
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