Insight: Asset managers farm out trading as costs and complexity climb
06/08/2019 06:05
(Repeats story without changes)
* Asset managers increasingly outsource their trading
* Face heavier regulation burden, rapid tech advances
* Demand for outsourced trading rises after MiFID II
* Niche sector set to grow 20-30% a year - researchers
By Thyagaraju Adinarayan and Helen Reid
LONDON, Aug 6 (Reuters) - It's 10 o'clock at night, and
Benjamin Arnold's day is just beginning. The former Goldman
Sachs trader is gearing up to trade equities in Asia from his
small office thousands of miles away in Park City, Utah.
He's not trading his own book, but rather is taking orders
and executing trades for a client, an Asian asset manager.
After almost 15 years working at hedge funds and banks,
Arnold launched an outsourced trading firm, joining a growing
crop of niche companies aiming to tap burgeoning demand for
outside help from small and mid-sized asset managers.
"There comes a time when you have to decide between standing
by and watching the world change or stepping up and becoming
that change," the 37-year-old said.
A heavier regulatory burden on money managers, razor-thin
margins and rapid technological developments in trading are
driving many to cut costs and hire outside firms to handle their
day-to-day trading.
The pace of demand has accelerated this year in particular
as asset managers feel the pinch following the introduction in
2018 of the EU Markets in Financial Instruments Directive (MiFID
II) which slapped more onerous paperwork on them.
It is as much as 40% cheaper for small to medium-sized fund
firms to hire an external trading company than employ two
traders themselves, according to interviews with executives from
more than a dozen asset managers, banks and brokerages, as well
as industry experts.
Michael Broadbent at Ergo Consultancy, which helps set up
trading desks and advises fund managers on regulation, has seen
a "giant switch" this year.
"It is almost impossible for an in-house trading team to
stay focused on every new and opening liquidity venue,
electronic broker, non-incumbent exchange and crossing network
while continuing to execute their existing business to a MiFID
II standard of best execution," he said.
The industry is still in its infancy, but industry experts
say it is one of the fastest-growing segments in prime
brokerage, which covers the complex financial services needs of
big institutions.
They reckon about two dozen firms offer outsourced trading
services with at least four, including Wells Fargo WFC.N , BTON
Financial and Arnold's Meraki Global Advisors, venturing into
the business this year. That compares with just a handful a few
years ago, they say.
Last month, mid-sized broker INTL FCStone INTL.O bought
U.S. outsourcer Fillmore Advisors to bolster its prime brokerage
offering.
The gap in the market being filled by boutique outsourcers,
like Fillmore, Arnold's Meraki, Tourmaline Partners and CF
Global, is prompting some big banks and brokerages to try to
grab a slice of the action.
Northern Trust Corp NTRS.O and Jefferies Financial Group
JEF.N , for example, have set up their own outsourcing teams of
traders working for a range of clients.
Such outsourced trading desks effectively work as units of
"buy-side" investors like asset managers, and include all the
analysis, administration and compliance services an in-house
team would provide. They are distinct from a bank or brokerage's
regular "sell-side" trading operations which simply execute
trades on a client's behalf.
GROWING POPULARITY
One in every five fund firms with over $50 billion worth of
assets will outsource some portion of their trading desks by
2022, according to research by financial consultancy Opimas.
Global revenues in the outsourced trading business are about
$450-$500 million annually and expected to grow 20-30% a year,
it said.
The practice of farming out trading functions has been
around for years, but it is becoming increasingly attractive for
small and mid-sized asset managers who may not be trading
frequently or in big enough volumes to justify the cost of
maintaining an in-house desk.
Opimas estimates it works out cheaper to hire an outsourced
firm if an asset manager's equities trader is handling less than
$1.5 billion in annual trading volume.
"We like to stick to our knitting," said Karen Zachary,
chief operating officer of Crux Asset Management, which uses
Northern Trust to handle all its day-to-day trading so it can
focus on strategy.
London-based EdenTree Investment Management, with 2.7
billion pounds ($3.28 billion) assets under management, is
considering outsourcing its dealings, said one of its fund
managers, Chris Hiorns.
By outsourcing, asset managers would typically spend about 5
basis points per trade, compared with the equivalent of around 8
basis points if they traded in-house, according to the market
players and researchers interviewed.
Experts estimate it costs about $1.5 million per year to
operate a three-member trading desk, and small to mid-sized fund
firms typically employ two to three traders. Then there are the
costs of reporting trades to regulators and additional
compliance due to MiFID II.
Needs vary among asset managers; some like Crux hire an
outside company to handle all their execution, while
London-based Hermes Investment Management, for example, relies
on CF Global for its emerging market and Asia ex-Japan equities,
and keeps its own traders for other assets. Some use trading
firms to cover inconvenient time zones like Australia.
$8 BILLION PER TRADER
For the banks and brokerages who are increasingly offering
outsourced trading, it represents a much-needed source of extra
income as they too have been squeezed by regulation and are
grappling with perennially low interest rates.
"The sell side is facing its own challenges, as fixed costs
are rising while the commission pool is shrinking," said Richard
Johnson, a senior analyst at research firm Greenwich Associates.
"Within this dynamic, outsourced trading desks have created
a strong niche and compelling value proposition."
U.S.-based Northern Trust ventured into the business almost
two years ago and now has 32 clients including Fundsmith and
Mobius Capital Partners.
Gary Paulin, head of institutional brokerage at Northern
Trust, said his outsourcing team of 18 traders processed equity
trades worth $145 billion last year for its various clients.
That's about $8 billion per trader.
Jefferies Prime Brokerage launched its outsourced trading
business in June last year, and now has 70 clients, according to
John Laub, co-head of prime brokerage at Jefferies.
According to Laub, under 10% of their start-up clients were
using outsourced trading in 2016, while the figure for start-up
funds today is "north of 70%".
Aside from cost savings, outsourced trading desks also offer
big broker networks, which are increasingly necessary under
MiFIDII.
The rules require money managers to prove to clients they
have traded in the most efficient way possible - known as "best
execution" - piling on extra pressure as they battle competition
from passive funds, which track markets rather than trying to
outperform them.
"It's a really cumbersome process with around 80 reporting
fields, it's a real pain and it costs money," said Paulin at
Northern Trust.
Tourmaline Partners, for instance, says it has access to 400
brokers through its almost 40 traders in London, Stamford in the
United States and Sydney, Australia.
They handled $175 billion worth of trades last year. Andrew
Walton, head of its European business, said he expects that to
rise by a fifth this year.
For experienced traders like Meraki's Arnold, this
fast-growing outsourcing sector also offers a new lease of life
as bustling trading rooms steadily dwindle in the era of
algorithms and automation.
"I believe that outsourcing in the asset management
community is still in an early growth phase and that more and
more managers will utilise firms like ours," he said.
($1 = 0.8237 pounds)
(Reporting by Helen Reid and Thyagaraju Adinarayan; Additional
reporting by Karin Strohecker; Editing by Josephine Mason and
Pravin Char)