Amid continued pressures surrounding costs, coverage, and operations, outsourced trading has remained a topic of fascination for buy-side firms seeking to optimize their business. But navigating the complex landscape of providers to achieve specific goals is far easier said than done.

Our latest virtual panel – “Outsourced Trading: Streamlining Operations for Enhanced Performance” – is designed to help with that effort. Over the course of the conversation, our speakers discussed key considerations in selecting an outsourced trading firm, some of the real-world applications of outsourced trading, and more.

This panel featured three industry leaders:

• Colin Kelly – Director of Research and Portfolio Manager, Signia Capital
• Matthew Krebs – Director of Outsourced Trading, CAPIS
• Jeffrey Estella – Principal, Estella LLC

Couldn’t join us? Here are a few of the key takeaways from the discussion.

All or Nothing?

One common misconception regarding outsourced trading is that it’s an all-or-nothing proposition: many investment managers are worried about giving up control. In reality, these firms can outsource as much or as little of their trading as they wish, working with a provider in a supplemental capacity. In any case, they should play a heavy role in defining the strategy employed by the outsourced trading firm. Estella covered this topic to lead off the discussion.

“I currently have two buy-side clients who leverage a supplemental model. This is not an either-or, but it is an ‘and,’” he said. “What I mean by this is that the existing internal trading desk works in conjunction with the outsourced provider in a scale-up or scale-down capacity. The outsourced provider is an extension of the existing effective trading desk.”

Outsourced Trading for All

Outsourced trading as a service offering has undergone an interesting evolution over the years. Krebs explained that while outsourced trading was historically most often geared toward emerging hedge funds or spin-outs to augment other prime brokerage services, it is now relied on by a host of traditional asset managers – family offices, endowments, foundations, RIAs, even pension funds – to overcome their challenges.

“People often cite headwinds such as cost pressures associated with fee constriction, regulatory demands, and a shift from active to passive as some of the initial catalysts behind this expansion across asset managers,” Krebs said. “But over time, it’s become more strategic in nature, particularly when you look at supplemental solutions.”

Outsourced Trading Use Case: Signia Capital

Kelly took the time to explain his firm’s experience working with an outsourced trading provider. Signia Capital maintained a small trading desk, which created key-man risk and made it difficult to scale into new markets. Engaging an outsourced trading provider has helped Signia Capital overcome these challenges. In addition to identifying a partner with the right trading capabilities, the firm heavily prioritized finding a provider with a clear communication style and an appetite for collaboration.

“From a key-man perspective, we had one in-house trader, and there’s significant risk in that,” Kelly said.
“We operate in a small market [using small- and micro-cap strategies]. An outsourced trading desk gives us global reach, which is a huge advantage for a smaller boutique firm like ourselves.”

Outsourced Trading vs. Sell-Side Trading

Fundamentally, outsourced trading providers are brokers, so there is sometimes confusion around how outsourced trading differs from more traditional sell-side offerings. Krebs explained that an outsourced trading firm is often a step closer to the investment process than a traditional broker – many clients give him a “front-row seat.” He also highlighted an outsourced trading firm’s ability to source liquidity from anywhere, as well as the ability to trade for either attribution or anonymity. Perhaps most compelling, though, was his take on the more consultative nature of an outsourced trading relationship.

“Often, I find myself engaged in conversation with portfolio managers well before a trade goes live, discussing pre-trade analysis, what might be the optimal execution strategy, liquidity constraints – all those things that help guide bringing a trade to life,” he said.

Funding Research: A Natural Outsourced Trading Use Case

Krebs explained one of the major reasons an outsourced trading provider might offer attributed trading, which is when the trade originates from the outsourced trading desk but the counterparty on execution knows who the underlying client is. This enables the underlying client to access the same sell-side research they would receive if facing these counterparties directly, informing their investment strategies.

Kelly explained his firm’s experience using this model, which has yielded significant benefits without curtailing access to research.

“We’ve utilized paying soft dollars through a third-party administrator, so our outsourced trading desk does all the execution, we share in that commission, and then we pay out that commission through our third-party administrator,” he said. “From a compliance standpoint, we can track exactly who we’re paying. Previously, we had an in-house trader who probably had 15-20 relationships, and we had to make sure we were sending trades to the appropriate brokers given the research. I think we’re now doing a better job tracking who we’re paying, how much we’re paying, and what kind of research coverage we’re getting.”

Interested in learning more about outsourced trading? Check out our outsourced trading resource center.