If you are responsible for trading at an RIA, chances are you’ve done a lot of thinking about outsourced trading over the past few years. In the face of growing costs, shrinking commissions, and ever-increasing client demands, this approach offers a wide array of benefits, and adoption has surged accordingly. This has sparked concerns among buy-side traders who believe outsourced trading’s meteoric rise is the beginning of the end for their role. Others fear giving up control of their trading.
Our advice: reconsider your perspective and embrace the disruption. Outsourced trading can be so much more than a reshuffling of responsibilities – it can produce powerful efficiencies that greatly expand your firm’s capabilities and bandwidth. In many cases, traders and other employees are not replaced, but empowered to focus less on the minutiae and more on their core competencies. This story is especially relevant in the wake of the pandemic, which did much to alter how we think about work and spotlight key issues to which outsourcing can be a solution.
While outsourced trading might not be for everyone, we’d argue that buy-side firms owe it to their clients to at least explore it – particularly RIAs and smaller investment managers, for whom the benefits of outsourcing are often more pronounced. Let’s explore some of those benefits, what they look like in practice, and why they’re so important right now.
New Efficiencies for RIAs
It’s no grand revelation to say that trading is complex. As buy-side firms grow and diversify, their trading responsibilities naturally increase – accommodating unique preferences, ensuring compliance, managing systems, and setting up new FIX connections are just a few examples. Because of their relative size, RIAs often struggle to meet these needs, especially during periods of rapid growth. And with greater demand for multi-asset strategies and “managed accounts” such as WRAP sponsors and custodial platforms, it’s not just an issue of bandwidth, but one of complexity as well.
Outsourcing is one possible solution – and crucially, it’s a solution that can take many forms. RIAs can leverage outsourced trading to expand their coverage, whether in terms of geographic location or asset class. They can extend their access to the sell side and source increasingly fragmented liquidity from new brokers. They can lock in coverage in the event of absences or unexpected departures. And they can get the most complex, painful aspects of the trading workflow off their plate, enabling greater focus on strategy and client service – in other words, the aspects that make RIAs stand out from the pack.
The pandemic has not only intensified these dynamics, but also contradicted some of the primary concerns around outsourced trading. Buy-siders who long insisted on the importance of having their traders in the same room as the wider team have now learned that a distributed workforce can still produce powerful results. And while many firms have returned to the office, others are still operating in a remote or hybrid capacity, exacerbating the challenge of training new traders. Still others are facing continued hiring difficulties, as the pandemic caused a significant number of financial services professionals to rule out in-office jobs or otherwise reconsider their career paths. Outsourced trading can solve these personnel challenges, often with more experienced traders than the RIAs would have been able to hire otherwise. That’s to say nothing of the IT, compliance and business continuity considerations that have been magnified by the pandemic. In all these ways, outsourced trading can serve to turn pandemic-fueled headwinds into real strengths.
This wide range of possible use cases is a major reason why buy-side traders should consider embracing their role in the outsourcing process, as many managers choose to engage outsourced trading providers in a supplemental capacity. No one understands your firm’s trading needs like the traders themselves – they intimately understand today’s market landscape, know where their team encounters inefficiencies, and can and should help to define the optimal solutions.
Commission Management: An Ideal Outsourced Trading Use Case
As mentioned above, cost pressures have been a key driver of the outsourced trading boom. Effective commission management is one of the best examples of how the right third-party provider can help RIAs ensure their total cost of trading is as low as possible.
Client commission arrangements (CCAs) and commission sharing arrangements (CSAs) can be fundamental to any outsourced trading offering. These frameworks help defray the cost of each transaction while helping to fund clients’ research budgets and extend their intelligence. While commission management services are not unique to outsourced trading, the broker-neutral posture and client-centric focus that often accompany this model can go a long way toward demonstrating best execution and compliance.
In addition, RIAs that run pension funds, mutual funds, endowments or foundations often receive special requests from their clients on commission recapture. This is a highly complex process that involves designating a portion of the block trade to be treated separately from a commission management standpoint, enabling it to be returned directly to the fund. It’s an important tool for lowering expenses, reducing commissions and controlling transaction costs. Hedge funds share these priorities, but RIAs are the ones who must handle them while accounting for such diversity of client requests, including those holding managed accounts.
This is why outsourced trading firms must offer an array of commission management and commission recapture solutions. In the case of CAPIS, that means tapping into the power of our best-of-breed algorithm suite, our global network of correspondent broker partners or even step-out trades that result in the best fill prices for every component of a large block. It also means illuminating TCA and brokerage allocation tracking, including through quarterly reports to help accounting and management personnel identify trends and spot outliers. We deliver the performance required to grow your assets while delivering the facts you need to demonstrate adherence to client requests and prioritization of their best interests. Everyone wins.
The Future of Outsourced Trading: Be Open to Innovation
Compelling as these use cases may be, some firms will still be hesitant to adopt outsourced trading. That’s understandable, but we’d argue that in this case, fear of the unknown may hurt your business. No matter what course you ultimately choose, the first step is education – so reach out to us for a conversation. We’d welcome the chance to explain in more detail how outsourcing can strengthen your current trading team, improve performance, and control costs, all while maintaining your unique approach.
In the meantime, you might benefit from exploring some of the research on outsourced trading that has been performed to date. These reports from Chartis and Tabb Group are logical starting points.
While there is a clear need in the marketplace for outsourced trading today, we predict that its value will only increase in the years to come. Between the move to T+1, the rise of meme stocks and new asset classes, and dreams of 24-hour trading – not to mention all the future innovations and regulations that are sure to emerge – trading is only going to become more complex. Having an outsourced trading partner in your corner can help, no matter where that help is needed.
