All outsourced trading services are not alike.
In the broadest sense, outsourced trading replaces some or all of the functions of an internal buy-side trading desk with a third-party provider—but as this fast-growing industry continues to establish itself as a critical part of the asset management landscape, it becomes increasingly important to differentiate between the various service offerings within the space. Here we take a closer look at three predominant models for outsourced trading, assess the strengths and weaknesses of each, and discuss several key considerations for asset managers working to identify the optimal choice.
Services can be separated into three models, defined by their core characteristics.
To enhance their prime brokerage and custodial services in an increasingly competitive environment, custodians and smaller investment banks are offering outsourced trading. The buy-side client has a single relationship with the provider. The execution broker housed inside the provider, a.k.a “outsourced trading desk”, executes trades for the client and passes the execution to their settlement and clearing group. The clients are provided with research, corporate access, and other services. The outsourced desk may also have relationships with other sell-side firms for execution, meaning the client is transacting with the provider. Ultimately, the outsourced service provider is the executing broker and stands between the client and other sell-side firms.
WHAT’S DRIVING THE GROWTH?
Asset managers are facing compounding pressures, including ever-increasing costs associated with operating a fund. To find ways to stay profitable and drive efficient growth, managers have significantly reduced the size of their trading desks in the last 20 years, replacing traders with software. Even so, desks and their systems are still expensive. At the same time, increasingly complex and fragmented markets alongside regulatory and compliance challenges are driving the need for more software and expert traders. These issues only make creating alpha harder, especially for small funds. With many asset managers struggling to justify a million-dollar desk, outsourcing has become a compelling strategy, delivering superior trading services in a cost effective way. In addition to lowering costs overall, outsourced trading creates the opportunity for asset managers to turn a fixed cost into a variable cost.
Providers act solely as the authorized traders for asset management clients. This structure allows the outsourced desk to be a truly independent, conflict-free extension of the client’s investment team, thereby operating in a pure buy-side capacity. In contrast to the models above, the provider does not have a clearing arrangement, conduct traditional brokerage activities, nor have any competing lines of business with clients’ broker-dealers. Clients settle all of their trades directly with their sell-side counterparty, which ensures all trades are booked into the funds account and all commissions and/or spreads paid to the sell-side are from the fund. Meraki has pioneered the pure buy-side model, a unique offering which is more akin to “cosourcing” than traditional “outsourcing.”
Building upon an understanding of the different outsourced trading service models, asset managers should ask themselves:
Some funds are looking for high-touch, experienced trading; others are focused on growing their broker network. Another way to approach this is to ask, which model would your desk most closely resemble if cost weren’t a consideration? Start by establishing core values—from here, it’s easier to weigh the advantages and disadvantages of the outsourced trading models
If the sum of the lost values is greater than the value of the single focus, then you may want to reconsider your focus. If, for example, you choose the prime brokerage model, are you limiting your resources and creating concentration risk? If you choose the agency model, are you limiting the products you can trade, forfeiting credit for your commission dollars, or receiving subpar execution? And if you choose the pure buy-side offering, do you have the ability and willingness to set up prime brokers, ISDAs, and execution accounts with your preferred counterparties?
At its core, the concept of outsourced trading works best when the service provider is structured so that conflicts of interest are removed and trust is nurtured between both parties. Funds should complete thorough due diligence into a firm’s policies and procedures to detect potential conflicts of interest and identify mitigating measures.
About Meraki Global Advisors
Meraki Global Advisors was founded with a rebellious determination to deliver truly conflict-free services to asset managers. Headquartered in Park City, Utah, with offices in New York and Hong Kong, Meraki provides outsourced global multi-asset trading, leverage management, and capital introduction services to the asset management industry. Meraki Global Advisors LLC is a FINRA member and SEC-registered. Meraki Global Advisors (HK) Ltd is licensed and regulated by the Securities & Futures Commission of Hong Kong.
For more information, visit the Meraki Global Advisors website and LinkedIn page
Contact:
Mary McAvey
VP of Business Development
(646) 666-7041
In the Driver’s Seat: How Hedge Funds Can Leverage Outsourced Trading Without Losing Control.
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