Once a niche offering largely geared toward hedge funds, outsourced trading has become an increasingly common practice. Today, sell-side firms offer a range of outsourced trading models that vary widely in terms of their functions, flexibility, and cost structures. This has created a great deal of choice for RIAs, but it has also created confusion in the market.
We’d like to do our part to clear up some of that confusion. Today, we’ll dive into three of the most common misconceptions regarding outsourced trading and how you can best leverage this versatile model for the success of your firm. Our hope is that you’ll finish this article with a few different ideas for how your RIA could benefit from such an offering, even if you’re not actively looking today.
Let’s explore each individual misconception and temper each one with a dose of reality.
Misconception: Outsourced trading is an all-or-nothing proposition
Reality: Outsourced trading can supplement in-house trading functions
We hear from many RIAs who say they would never consider outsourced trading because there are particular tasks they prefer to keep within their own walls. But outsourced trading doesn’t have to mean outsourcing every single trading function – it can supplement in-house efforts, focusing on discrete functions based on each desk’s unique requirements. This is why you’ll often hear us refer to our offering as “outsourced and supplemental trading.”
By design, this model is extremely flexible – RIAs can apply it to just about any challenge. For firms seeking to support more global or multi-asset strategies, outsourced and supplemental trading is a logical way to quickly move into a new country or asset class. Firms facing operational challenges can outsource the most laborious tasks while keeping alpha-generating activities in-house. Firms facing personnel departures can ensure a seamless transition while recruiting at their own pace.
RIAs can also outsource as much or as little of their trading as they want. Established firms with a well-staffed desk can outsource a small portion of their day-to-day trading for contingency planning purposes, ensuring seamless business continuity in the event of unforeseen circumstances. On the flipside, a new firm could outsource 100% of its trading and operations at launch and gradually bring certain functions back in-house, depending on its business plan and hiring roadmap.
Bottom line: outsourced and supplemental trading can support your needs, no matter how specific or all-encompassing they might or might not be.
Misconception: Outsourced trading is only for firms looking to reduce headcount
Reality: Outsourced trading can augment the capabilities of your existing personnel
This point is related to the one above. But it’s distinct because it addresses one of the fundamental fears about outsourced trading: that it’s a precursor for laying off in-house traders.
While it’s true that outsourced and supplemental trading is a good solution for personnel gaps, it can also be an effective way to free up time and help employees focus on doing what they do best. For example, if significant turnover on your trading desk is spurring your firm’s decision to outsource, it could make sense to retain that operations manager who is great with clients and has a knack for the order creation and settlement process. Similarly, if you have a robust team of highly knowledgeable traders with a reputation for turning ideas into alpha, outsourcing only the most time-consuming operational functions can be the right move.
RIAs that sub-advise retail accounts using multiple WRAP and custody platforms provide a tailor-made use case for the latter approach. Instead of undertaking highly complex and ultimately unfair trade rotation processes, these firms can engage an outsourced and supplemental trading provider to trade away in search of best execution. In this case, the provider would oversee functions like handling DVP settlement and net commissions to the WRAP and custody platforms, all while potentially enhancing the RIA’s access to the sell side. It might require a tough conversation with those platforms, but it’s ultimately a fair, workable model that allows for as many winners as possible.
Bottom line: it’s very often easier to outsource complex or ancillary functions to a third party, regardless of any current or future personnel decisions.
Misconception: Outsourced trading forces firms to give up control of their trading
Reality: Outsourced trading can enable firms to control as much or as little of their trading as they wish
Many RIAs fear that if they outsource any portion of their trading, they will no longer be able to influence the process. Nothing could be further from the truth. Outsourced and supplemental trading can and should be a careful reflection of the client’s strategies and preferences, giving them significant control over the ultimate results.
For us, it all comes down to choice. Firms should be able to outsource any amount of their trading in any area – and they should be able to determine what that trading looks like. This flexibility is crucial, so proceed with caution when evaluating potential partners. The right solution should not lock you into trading with an associated prime brokerage business or using rudimentary technology platforms that limit your reach. And it certainly shouldn’t be associated with any proprietary trading businesses that could add perverse incentives to the equation.
Commission management is a good example of the value of retaining control. For RIAs that wish to outsource a portion of their trading but continue to pay for research from a particular broker, the outsourced trading provider should be able to accommodate that specific preference through attributed trading. Ultimately, if the provider is unable to transact with a particular counterparty due to its business model or conflicts, then it isn’t truly replicating a buy-side trading desk. At that point, it’s fair to question whether the “outsourced trading” label is even appropriate in the first place.
Bottom line: outsourced and supplemental trading should be tailored to the needs of each individual client, and offered via a model that allows for this tailoring. The process should always start with a consultative conversation.
Conclusion
While we don’t claim to have all the answers, we hope this article has addressed at least one question you had about outsourced trading – and that it will spark future conversations within your firm. There’s virtually no limit to how outsourced and supplemental trading can protect your bandwidth and support your strategic goals, and it certainly doesn’t have to come at the expense of your existing capabilities, talent, or preferences.
At CAPIS, we strive to offer outsourced and supplemental trading services that reflect these considerations. We listen to your challenges and offer solutions based on them – not the other way around. We are knowledgeable, versatile, and multi-asset, so we can handle any aspect of your trading and operations. We lack conflicts that would hinder our ability to cater to your needs. We do all of this in an economical fashion that accounts for the realities of your business.
When the time is right, we encourage you to reach out, set up a conversation, and experience the difference for yourself.
