Building trust: The value of an agency-only outsourced trading desk model

For some firms, the decision on whether to outsource or co-source the trading desk is a no-brainer. Take, for example, a small or mid-sized hedge fund that is looking to expand into new areas. It may need more trading capabilities than it could hire on its own within a reasonable timeframe. In such a case, outsourcing some or all of its trading requirements is clearly the most sensible option.

For other firms, the decision is more complicated. It can lead to internal debates about what kind of value in-house traders actually provide. The debates are not always easy to resolve because they are often subjective. Of course, a firm can consider the question of best execution and look at TCA data. But some asset managers see added value coming in multiple other forms.

One factor that looms large in these discussions is trust. Is an outsourced trading desk provider merely selling a service, or is the relationship more like a partnership, one based on aligned interests?

The litmus test for us, as an outsourced trading provider, is whether the client can begin to see our traders as their traders. If we can reach the stage where it feels like the line is blurred and a trader who works for our firm is basically an extension of the client’s firm, that’s a clear indicator that we’re doing our job well. But how does one get to that stage, and what value does it generate for the client? Let’s talk about the “how” question first and then look at the “what” question.

Establishing trust

There are several ways that an outsourced trading provider can build trust with a client. The simplest way is to do a good job, based on whatever measure the client wants to use. If lowering transaction costs and achieving best execution is the objective, it’s not difficult to look at the empirical evidence and take a view – Cowen uses an independent firm to provide the client TCA reports.

Some clients may want to just VWAP and TWAP an order over the course of the day. Others may be more aggressive and will want to take a different approach. Given the strength and depth of the traders that Cowen has, we know we can help firms achieve whatever execution objectives they have. But we also recognise that some firms like to start slowly. A lot of the conversations we have are educational. People need to get comfortable with the concept of outsourcing or co-sourcing.

A second way to build trust is go above and beyond the call of duty. When a trader works in-house, there are clear incentives for performing well. How can an asset manager be certain that someone working at an outsourced trading provider will do the same? A provider that wants to build a strong relationship with its clients must foster a culture that pushes the traders to go the extra mile. In a recent blog, one of our traders talked about making some extra checks to get short interest colour for a client who was considering shorting a stock. The trader didn’t need to do that, but he knew it would help the client make a good decision. For the client, that kind of forethought speaks volumes. A third way is to ensure that the provider’s and the client’s interests are aligned. The universe of outsourced trading desk providers is broad. It features a range of firms, from investment banks to custodians to non-bank liquidity providers, each with different models. One of the main attractions for using a provider with an agency model, such as Cowen, is that the client gains access to the provider’s extensive network and sources of liquidity. That directly influences the ability to deliver best execution. An agency-only model also means that the provider’s interest is solely to provide excellent service. There is no question of the outsourced trading desk provider trading against its own book, because it doesn’t have a book to trade against.

Why trust matters

One of the main benefits of using an outsourced trading desk provider is that it lets asset managers focus on what matters to them: their investment strategies. As trust grows, this benefit only increases. Some asset managers, particularly those who have traded themselves, may want to micromanage a large order. But as they see that a provider is able to not only meet but also anticipate their needs, they can devote more of their mental energy to their investment process.

Trust is important not just because it means a firm can rely on its service provider to do a good job. It also provides the foundation for an extended relationship.  Some funds may want the provider to simply handle trades. But others might want operational support. They may want a quasi-accountant who can support NAV calculations. Or, they may want help with raising capital. There are a range of services that go beyond execution, and an outsourced trading desk specialist can be the partner to provide them.

We take trust so seriously that we ensure that our outsourced trading service is entirely separate from the firm’s other business activities. That is more than a legal distinction. It’s physical. We use a separate order management system, and the operations, compliance and systems are all walled off.

Ultimately, we want our clients to know one thing. When they outsource or co-source with us, their goals are our goals. It’s that simple.