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Questions of value: How costs and benefits stack up from outsourced trading

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Say the word “outsourcing” and the first thought that comes to mind for many people – regardless of the industry – is “cost-savings.” The terms are so inextricably linked that the word produces a knee-jerk response. It’s unfortunate because in some fields, the practice of outsourcing is about far more than cost. That is certainly the case when we talk about outsourced trading desk solutions.

In fact, when we meet with asset managers and trading firms of various types and sizes, we generally focus on what an outsourced trading desk adds to a firm in terms of skills and reach, rather than what it takes away from the firm in terms of costs.

But that doesn’t mean that cost is not a big issue. The fact of the matter is, depending on a firm’s needs and the relationship it wants to form, an outsourcing partnership can have a dramatic impact on operational costs, which of course flows through to the bottom line. And we mustn’t forget that we’re talking here about an industry where margins have been consistently under pressure for the better part of a decade. For firms in Europe and Asia, having begun to see the many arguments in favour of outsourced trading desk solutions, the proof is in the pudding. The pudding in this case is the U.S. market. U.S. asset managers have been quick to employ outsourced desks because they are cost-effective. These firms have a long tradition of whittling their cost bases down to the bone, so it’s hardly a surprise that outsourcing has become so prevalent there.

Hidden value

People tend to focus on an experienced trader’s salary as the main benchmark, but in fact there are many other issues that feed through into the cost-benefit calculator. For instance, when a firm works with Cowen, it is not just getting value from our traders, it is also getting value from our infrastructure. An outsourced trading provider, in order to offer a premium service, needs to invest in state-of-the-art technology such as our custom order management system.

The technology factor became clear during the pandemic. It boils down to a question of scale. Because we had invested so heavily, we were able to handle volumes that on occasion were two to three times the normal sizes, without any hiccups while in remote setups.

That leads to another aspect of an outsourced trading desk relationship that can greatly affect the operational cost base. Because outsourcing increases a firm’s flexibility, it means asset managers can optimise their in-house staff – whether working on site or from home – to fit their needs.

This offers benefits in two distinct ways. The first and most obvious way comes from the reduction of fixed costs. It’s not just the salary. It’s licensing, insurance, office space, workstations and a whole host of ancillary costs. Those costs effectively vanish when a firm moves to an outsourcing arrangement.

A second benefit springs out of that. Having an outsourced trading desk means a firm has far more flexibility. Volumes can be increased or decreased on a day-to-day basis, without firms having to think about increasing or decreasing the in-house team. In other words, it is not just that the fixed costs are reduced. It’s that the variable costs that replaced them can be adjusted so quickly and easily. And those variable costs are able to generate a lot of value. Cowen has several dozen traders. For most asset managers, it would be impossible to hire traders with that much collected skill and experience. The cost would simply be prohibitive. Those traders can extend a firm’s geographic or asset class coverage, or they can add extra capacity for busy periods, all of which creates additional value.

Pressure to deliver

Funds are like any other businesses. They are under huge pressure to deliver healthy margins. When times are good, that’s less of an issue. But the pandemic has offered a timely reminder that the environment can suddenly turn dark without warning.

This matters for all funds of all sizes, but it matters in particular for smaller to mid-sized funds. They will always have a sense of their breakeven cost. The larger the proportion of that cost that is variable, the greater the fund’s scope for operating above breakeven. At the same time, as fee compression continues, the emphasis on the cost side of the equation will only increase.

There are many reasons why some firms will want to retain in-house traders. It may be because the trader has certain key skills or relationships. It may be because a fund operates as a kind of organic unit, where the traders perform key roles over and above the trading function. Because Cowen’s team is made up of trading firm veterans, we completely understand that. But for those firms, we have one word: co-sourcing. It offers a best-of-both-worlds proposition, where firms can keep in-house traders for specific needs and enjoy the cost-benefit aspect of outsourcing.

Either way, the arguments in favour of partnering with a trading desk provider are becoming increasingly hard to ignore. We expect that as Europe and Asia look to emulate the success of a thriving fund industry in the United States, outsourced trading is likely to become an even greater focus.

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