Buy Side Eyes Outsourced Trading Amid Covid Disruption

Seesawing markets are forcing many buy-siders to reassess how they operate, as coronavirus upends the norms of trading. But for one segment of the industry, the disruption may bring an opportunity: outsourced trading firms.

Many are reporting interest in their services from asset managers struggling to cope with higher-than-usual trading volumes and volatility, or looking for back-up options. Dislocated markets are also pushing portfolio managers to explore unfamiliar asset classes in a bid to improve performance, and outsourcing is an outlet for those who lack the necessary expertise and relationships.

“This pandemic has definitely increased the inquiries,” says Jeff LeVeen, head of outsourced trading at US firm Jones Trading.

Greg Sutton, chief operating officer at outsourced trading firm Meraki Global Advisors, says the company has had “a lot of initial conversations” since the onset of the pandemic.

• READ MORE: Fee compression and regulations have forced some asset managers to rethink what is core to their business, including the trading desk. Enter the outsourced trading desk. Click here to read more.

Outsourced trading firms, which take on some or all of a buy-sider’s order execution, have picked up business in recent years as asset managers look to reduce costs of hiring traders, transacting in various time zones and maintaining necessary technology. The virus may be turbo-charging that trend.

Risk.net spoke to six outsourced trading firms that say they have seen increased interest from prospective clients during the current pandemic.

Business continuity is a motif in conversations with prospective clients, outsourced traders say. The crisis has forced companies to focus on maintaining key business functions in disaster scenarios where their traders are unable to work from the office or, if they are ill, unable to work at all. In recent weeks, asset management firms have had to reduce the number of traders working in the office, sending a large share of them to work from home or from external disaster recovery sites.

“I think the Covid crisis has in a short time greatly increased awareness of workforce vulnerability and is forcing all of us to consider solutions for the next interruption,” says Chris Hurley, director of institutional sales at Capital Institutional Services (Capis), which provides outsourced trading.

Outsourced firms are not necessarily better equipped to handle trading during a pandemic – their traders, too, are likely to be split between their own homes, the office and auxiliary sites. But the firms are positioning themselves as a back-up plan for asset managers looking to ensure they can continue trading in a crisis.

Some outsourced trading firms are also looking to make a virtue of their location in out-of-the-way or unfashionable areas. Meraki is based in Park City, Utah, while the headquarters of Capis are in Dallas, Texas. The two companies claim an advantage in having a base outside of the main financial centers of New York, Chicago or London during the coronavirus pandemic, which has seen infection rates spike in densely populated cities.

Gary Paulin, global head of integrated trading solutions in Northern Trust’s institutional brokerage business, which offers outsourced trading, says the September 11 terrorist attacks prompted many large US banks to build disaster recovery sites away from the city, in New Jersey and elsewhere. He says pandemics are the next big crisis that will “inform how all of our asset management clients need to think about disaster planning going forward”.

Roller-coaster ride

Hand in hand with the displacement of staff is a spike in volatility not seen for a decade, with various measures surging in the second half of March (see figure 1). The Vix index, which gauges equity volatility on the S&P 500, rose 500% from levels at the start of the year. Similar spikes were visible in Treasury market volatility, with one measure up roughly four times from its January level, and in oil markets where volatility jumped over six times higher than levels from January.

The flux has sparked a flurry of trading as firms rush to enter or exit positions, lay off risk, or adjust strategies. Some asset managers may be unable to handle this increase in trade volumes internally. At one of the larger outsourced trading firms, Tourmaline Partners, European business head Andrew Walton says the firm has seen a growth in trade flows from clients, notably a heightened demand from managers that “want to work with us in a supplemental capacity”, referring to clients that outsource a portion of their trading to Tourmaline.

Outsourced desks may have a wider range of trading platform and interpersonal connections than managers who typically focus on one or two asset classes. With volatility in March spreading across markets, Meraki’s Sutton says clients used the firm to trade products with which they’re less familiar.

“You might have an equity-focused fund that now wants to get involved in debt – or they see some opportunity in commodity markets or rates – and maybe their traders don’t have access or expertise in those markets,” he says.

As ever, cost is a key part of the equation. Running a remote trading facility is an expensive business, especially if firms want to maintain “like-for-like capabilities” in terms of technology, such as multiple computer screens per trader, and connectivity, says Paulin at Northern Trust.

For firms wrestling with the operational disruption of the pandemic, it may be cheaper to hive off part, or all, of their trading. Outsourcing firms tend to work under a plug-and-play model, which means clients bear no fixed cost. A permanent back-up site, on the other hand, represents a permanent expense.

Cost pressure may be especially acute if falling markets cause assets under management to drop, along with associated management fees, says Hurley at Capis, adding: “We are already starting to see it.” Much of the sector is in the grip of a cost-cutting drive in part due to the shift to passive fund management with its paper-thin margins.

However, not all outsourced traders are willing to be used as a buy-side disaster recovery option. Northern Trust, for one, is wary of such an arrangement.

“If we’re already dealing with outsized volumes and volatility and then someone rings up and says, ‘you need to be my disaster recovery site today’, it would introduce too much uncertainty for us,” says Paulin.

Asset managers, too, may be resistant to outsourcing. Some worry about losing control and sacrificing existing relationships with dealers. Others see their trading operations as too complicated to pass off to an external firm.

Outsourced traders counter that they can give managers’ orders more clout since the outsourcing firm faces dealers as a larger trading entity and can more easily maintain and leverage relationships with brokers across the globe. The result could mean better fund performance.

They also trumpet the convenience of the service. New clients can be set up more quickly than hiring extra traders, says Daniel Shepherd, chief executive at BTON Financial, where onboarding can take two weeks. Depending on a client’s size and requirements, some say they could be trading on a new client’s behalf within days.

With the Covid pandemic reinforcing the need for business continuity planning, how managers respond could become a key part of future risk management assessments.

“That’s going to be a due diligence question now: what did you do and how are you prepared for the next issue that comes up?” says Sutton.

Editing by Alex Krohn