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Wider horizons: The case for using a full-service outsourced trading provider

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Before the Covid-19 pandemic struck, global equity markets had been on a historic bull run. The suddenness of the market collapse was a stark reminder of the dangers that can come with riding a wave.

Now, following an equally steep recovery, and with the prospect of above-trend global economic growth in the coming years, markets have been surging again. Yet many fund managers are uneasy, questioning how high equity valuations can go. Downside protection, despite the economic optimism brought on by the rollout of effective vaccines, appears to be getting increased focus after the experiences of the past year.

Successful trading in such an environment typically goes beyond the long-short or long-only equity strategies many asset managers employed during the bull trend. That’s in line with what we’re seeing in terms of fund launches. We are hearing a lot more from multi-asset strategy launches than single asset launches as new funds look for different ways to express their views.

But the trend towards multiple asset class trading has much deeper roots than the pandemic. There has been a huge shift in fund behaviour going back many years.

Benchmark provider FTSE Russell, citing data from Boston Consulting Group, wrote last autumn that multiple asset class funds were the fastest-growing segment of the global asset management sector of the past decade, with $11 trillion in AUM. That total is more than five times the 2003 figure of $2 trillion and the total market share of multi-asset funds has jumped to 14% from 6% during that time.

What that means is that every year, there are more funds expanding their horizons and adding new asset class capabilities.

At the same time, another trend has also been gaining momentum, namely the increasingly wide embrace of outsourced trading desk solutions.  As these two trends coincide, it is pushing asset managers to think carefully about what kind of outsourced trading desk provider to consider.

Skills and relationships

Funds that are venturing into new asset classes are immediately confronted with fresh challenges. It’s one thing to develop trading strategies that can thrive in the current environment. It’s another to actually trade those strategies effectively. Hiring specialists with additional asset class expertise, such as in fixed income, derivatives or foreign exchange, can be expensive and time-consuming.

One of the most daunting issues concerns sourcing liquidity. Fixed income, for instance, requires expertise not just in terms of the actual trading but in terms of managing the liquidity providers. As one of our veteran traders says, it’s old-school. It involves who you know, not just what you know. Forging the right relationships takes time and experience.

This is one of the reasons Cowen has been pioneering outsourced fixed income trading while also building up its team with foreign exchange and derivatives specialists.

Fixed income does not have centralised exchanges or liquidity that is visible to everyone. Only the biggest money managers typically get top-tier access to liquidity providers. A fund manager can find brokers who can provide that kind of access, but it comes at a cost.

The expertise required extends into a lot of other areas too. An experienced credit dealer will understand the trading ecosystems, be aware of the latest technological innovation and know the vendors. A simple example of the added complexities in trading fixed income versus equities can be seen in the price discovery process. Successful credit trading requires more than a data feed. It involves aggregating and presenting pricing data from an array of disparate sources.

Then there is the question of indicative pricing versus firm pricing. Many liquidity providers will offer prices on an indicative level, but a trader needs to be able to filter out what’s truly executable. Unlike with equities, an asset manager cannot look at a screen and instantly know where an asset is trading. Think of it like the difference between buying a chair from a furniture chain or going to an antique dealer. Knowing what is in the market, where it is trading and how to arrive at a price is all part of the job.

Finally, while much of fixed income trading has become electronic, a substantial amount is still done by voice. That requires its own set of skills, expertise, experience and relationships.[EC1] 

If all of that sounds like a lot to think about, it’s because it is.

But that’s also why an outsourced trading solution can be attractive. Even if a firm just wants to dip its toe in the water, say, by trying out a new asset class there is the option with the Cowen solution that allows the firm to outsource the execution of those assets starting out small with no large upfront costs.

In the years ahead, multi-asset class funds are expected to grow even more, both in absolute terms and as a share of the industry. From our perspective, it only adds to the argument for why outsourced trading desk solutions make so much sense.

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