Published on TABB Forum, December 2020
How does a money manager choose the right brokerage firm to do its trading, or what is commonly referred to as outsourced trading? Daniel Shepherd of BTON offers four areas that a buyside firm should evaluate before making a decision, as well as other insights.
In the midst of these unsettled times, asset management firms are reexamining their access to both markets and clients as they continue to work remotely and grapple with the impending fallout of a future recession. Firms nowadays are being forced to react quickly to fast-moving events and hard-hitting business environments. But can these dealing desks access any supplementary tools to gain a vantage point in terms of flexibility and operational efficiencies, all the while maintaining alpha?
Our daily conversations over the past few months with senior staff at multiple asset management firms (ranging from over $500bn AUM to small & emerging managers) have provided us with some interesting insight. Each is extremely concerned that we are about to enter into a fairly chunky recession, the impact of which will have the inevitable knock-on effect of fund margins being squeezed even further.
Firms will need to face up accordingly, meaning they will have to focus on economies of scale and synergies like never before. This includes a review of their ability to access and navigate volatile, turbulent markets. Take, for example, the value of a trader executing an equity VWAP algorithm over the course of the day, versus a trader executing more esoteric instruments. It is hard to argue that in the instance of the VWAP trader, his or her work could be considered as a ‘value-add’ activity. In fact, it could even be further contended that the process of executing the VWAP trades would be more cost-effectively managed by an additional channel that automates that process.
Independent, broker-neutral dealing desks
What can help investment managers in their quest to not only reduce costs, but to also focus on identifying alpha-generating trading opportunities and producing returns for the end investor, is the addition of an independent, broker-neutral dealing desk tool alongside their existing operations. Through the use of a data-driven routing technology, investment managers can effectively implement trading strategies and make sure that their investment intentions are not undermined by poor execution quality as a result of inadequate technology.
But what should asset management firms look for when updating their front office model via the use of independent broker tools?
Firms need to assess potential providers on their core strengths, and evaluate the following:
- Control retention: Whilst trading may no longer be deemed part of the core business at asset managers, most won’t be keen to just ‘throw it over the fence’. Heads of trading need to continue to add value at the same time as achieving scalability. A provider of an independent dealing desk should have ‘volume control’, so that you can rotate higher as your firm becomes more comfortable with the outcomes;
- Independence: If one is to really achieve a market-leading best execution then firms have to maintain a large broker list to ensure competition in their marketplace, and continually compare and contrast brokers to ensure best performance in multiple trading environments and situations using as many metrics as possible;
- Data & KPIs: Oversight is key. If data is an asset that provides a competitive edge, will your trading partner provide access to the high-quality data you require and, importantly, use it effectively? ‘Insourced’ dealing desk technology can help solve a problem that has confronted asset managers for years – that of quickly and easily evaluating broker performance pre-trade, by leveraging collaborative, anonymised post-trade data so that broker performance can be properly measured. Heads of trading desks have long lauded the potential of using collaborative data to improve trade performance. But the nature of proprietary data sets and the risks of them becoming public have always thwarted any possibility of a buy-side collaboration in this area. This is no longer the case as the new FinTech ecosystem around asset management grows. KPIs and solid transaction cost analysis should be an integral part of the solution for your best-ex committee, transparent, objective, evidence-based analysis to empower your firm, ensure best execution and provider’s performance;
- One-stop Shop?: Whilst outsourcing to a single provider might well be a compelling idea for asset managers, firms could be limiting themselves and their tech development. They are potentially increasing dependence on a single provider, reducing the ability to negotiate the cost. One size does not fit all, and a very large partner may be less willing to facilitate specific customer requirements without adding significant cost. Firms should select a provider whose core business is actually trading. Rather than using enterprise software or a basis-point commission-based model, delivery should via a clean transparent model and cloud-enabled SaaS.
Of course, all investment managers have their own unique workflows. Rather than opting for a ‘one size fits all’ insourced dealing desk, clients should look for a data- and technology-driven approach to complement existing in-house capabilities. Close collaboration with the vendor needs to occur so that dealing desk technology can be easily and quickly integrated into workflows, operational and trading infrastructure.
Extension of your business
One thing is for certain, as firms try to adapt to this challenging new world, those in a position to best invest in innovative tools & technologies and take advantage of new liquidity opportunities will be the ones that succeed in delivering returns for the end investor. Ultimately by using insourced dealing desk technology, investment managers can gain an additional channel to deal with unprecedented situations by reducing operational overheads, streamlining operations, and simultaneously improving execution outcomes for their end clients. When dealing with turbulent market conditions, fund managers might find it prudent to invest in innovative approaches to help guarantee optimal outcomes.