No easy money in 2023: is it time to outsource trading?

Financial institutions have been through a tumultuous year, with investment managers caught up in the fallout of a global cost-of-living crisis, the highest inflation in decades, and rising interest rates that are expected to power higher in 2023.

As financial market volatility accelerates, there’s no question that money will be tight in 2023. Firms will be prioritising initiatives to cut costs and streamline processes, generate new products and revenue opportunities, and increase their client base. With this in mind, will this be the year when more buy-side managers than ever before turn to outsourced trading?

Global investment bank Cowen has a two-decade track record in outsourced trading, and saw its revenue in the sector rise by the mid-30s% in the last year. It sees outsourced trading growing further in 2023, particularly in the UK, EU and Asia. Here are five themes likely to come to the fore in the year ahead.

Offsetting growth concerns and cost efficiencies

With a strong push for cost efficiencies at a time when firms may be seeking to adapt their strategies to sustain performance, outsourced trading presents an attractive business case. While its benefits are many, there is overwhelming agreement that outsourced trading offers a cost- and time-efficient way to access trading expertise.

“Outsourced trading is increasingly in demand as it allows fund managers, whether they are established or new launches, to scale more efficiently than hiring and managing new headcount and infrastructure, and it also allows them to access expertise in supplementary global markets and asset classes,” said Jack Seibald, global co-head of prime brokerage and outsourced trading at global investment bank Cowen.

There may also be multitude value boosting bells-and-whistles. Some providers, like Cowen, offering a host of pre- and post-trade operational support services. This can include trade clearance and settlement, portfolio reconciliation and reporting, trade cost analysis, commission management and more.

Even firms that run their own trading desks can supplement their team and leverage these benefits. Outsourced trading isn’t purely reserved for those looking for an alternative to running an in-house trading desk.

With a spotlight on cost efficiencies this year, managers will be extremely mindful of over resourcing and outsource trading provides a compelling alternative. For example, a fund trading a new asset class may only warrant half a headcount, but a full-time specialist trader needs to be hired. And what about back up? Make that two traders. This could equally apply to a firm looking to move into a new geography. Outsource trading can meet the business requirement without the surplus expense.

Institutional investors and larger hedge fund managers, who have hitherto overlooked the benefits of outsourced trading, increasingly see it as the smart thing to do, especially in a time of falling AUM and flattened fees, industry insiders say. Given the uncertain economic outlook, outsourced trading is likely to be seen as a very relevant solution for a broader range of asset managers, including established buy-side firms, family offices, endowments and pension funds.

Outsourced trading is not an all or nothing decision

Outsourced trading business models are evolving, offering clients more choice. In a full outsourced solution, funds choose to outsource all their trading needs. But it is not only about substitution. Some firms want to continue running their own trading desks.

The challenging economic climate has prompted some fund managers to take a creative approach to their investment strategies, seeking opportunities in other asset classes or geographies. Those looking for a quick and easy way to diversify trading strategies could turn to supplemental outsourced trading – or as some in the market call it, co-sourcing.

For example, an equity-focused fund may find it needs to trade in fixed income but lacks expertise in the asset class, so just outsources its bond trades. Another could be cross-border trading. Any firm with exposure to multiple time zones has to consider the number of traders required to have adequate coverage.

Other reasons to call in supplemental help might include handling an exceptionally large order flow, or the need to remain anonymous.

Going with an outsourcing provider means gaining expertise and economies of scale when they are needed to support an existing trading desk.

Choosing a provider is not a level playing field

The momentum behind outsourced trading is strong and getting stronger, attracting more providers to the market. In fact, research firm Coalition Greenwich said in a report last year that the number of vendors had risen 400% in the previous four years.

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. Some leverage the infrastructure and headcount of an existing ‘internal’ desk that trades for its own accounts. Others offer a pure buy-side agency-only outsource trading solution.

Before signing up for outsourced trading services, it is important to ‘kick the tires’. Here are a few things to bear in mind.

Look into the business structure and ensure that the provider’s interests are fully aligned with your own. One of the main attractions for using a provider with an agency model, such as Cowen, is that firms know that the trading they outsource is executed for their benefit and their benefit only.

Is the trading desk geared for the buy side? Has it kept its technology up to date and is it, like Cowen’s, built for the buy side. Does your outsourced trading provider have access to an extensive network of brokers and liquidity sources that will facilitate best execution? Does it have traders experienced in the required asset classes and geographies? Perhaps ask them whether they have traded through a recession before, or a period of rising interest rates. Not all will have.

Also, check how many clients each trader is trading on behalf of. Cowen, for example, has one trader for every four or five outsourced trading clients which is optimal in a fast market. Some competitors have more than double the number clients per trader, leading to more reactive (versus proactive) trading coverage.   

Can your outsourced trading provider offer other value-add services, such as trade settlement, portfolio reconciliation, trade cost analysis, access to research, capital introduction, deal-flow and corporate access.

By contrast, with its global banking pedigree, its long-term links with brokers, and more than 40 traders, mostly with buy-side experience, across the U.S. and in London and Hong Kong, 75+ operational support staff and 200+ institutional brokers, providing research, corporate access and capital market flows, Cowen ticks all these boxes.

Outsourced trading offerings will proliferate in 2023. Choose the right one.

Outsourced trading opens doors, spotlight on fixed income

Funds that were previously exclusively focused on equities are seeing potential profits in fixed income. For this, they need the skills of expert bond traders. This expertise is available from the right provider, including Cowen.

In the past two years, Cowen has developed solutions in the credit markets. The team was built from scratch as the credit markets work very differently from equity markets. Much of the trading is not on an exchange and pricing is more subjective. Access to liquidity is vital, especially with rarely traded bonds and when a large order needs to be executed efficiently.

What differentiates the fixed-income space is that access to liquidity is not the same for everybody – it’s all about size and presence. If a smaller fund manager wants to feature prominently on a broker dealer list, outsourcing gets a bigger seat at the table and allows firms to engage with liquidity that they would be unable to access otherwise. However, where the fund has a large market presence already, the outsourced trading provider can make sure brokers are aware who the trades are for and ensure that position is maintained. With a highly experienced team, large counterparty base and market platforms, Cowen is seeing a significant increase in demand for the service.

Outsourced trading can help future-proof your business

Covid highlighted the need to prepare a business for anything, from a pandemic to a flood or a cyber attack. The UK’s Financial Conduct Authority introduced new financial resilience rules last year and it is expected that similar strictures will follow in other jurisdictions.

Using the services of an outsourced trading provider can strengthen the operational resiliency of a firm without it having to make substantial new investments. Larger outsourced trading providers, such as Cowen, are required to meet the new requirements, which translates into extra resilience for clients.

Additionally, for firms that trade in multiple markets and geographies, an outsourced trading solution with a follow-the-sun model brings extra advantages. And it’s not just external forces that firms need to worry about. Technology issues or staff absence also point to the need for expert support to call upon if needed. Teaming up with the right outsourced trading provider can help mitigate the risk of such problems.

Final thoughts

Outsourced trading looks set to expand further in 2023, among fund managers large and small. It makes strategic, operational and financial sense and could increase the firm’s operational resilience.

But choosing the right provider is vital. Cowen says three features differentiate its solution, perfected over two decades. These are its buy-side focus; its comprehensive solution that offers execution in markets across the globe by experienced traders, integration with clients’ trading technology and pre- and post-trade support; and its flexibility in delivering outsourced trading as a full or supplemental service.Cowen, renowned for its “white glove” level of service, promises to function as nothing less than the client’s trading desk.