Outsourced trading demand is increasing as investment firms look to reduce costs, satisfy regulatory demands and expand into different markets. COVID-19 demonstrated to many fund managers that not everything needs to be operated in house. In fact, some processes and functions might actually perform just as well in a remote and virtualized environment.
According to a new paper from Capco – Outsourced Trading: Who, What & Why Now? – which looks at why a growing number of firms are looking to use or provide outsourced trading as a service and identifies key emerging trends.
Typically, smaller hedge funds and other investment managers outsource trading to a brokerage firm, however, the paper shows that many of the largest organisations may begin outsourcing some or all their trading within the next few years.
The paper, co-authored by Capco’s head of prime brokerage (UK) Anthony Bennett and executive director Andrew Dearman, noted that as technology, transparency and service convenience increases, outsourcing is becoming more widely adopted to support core hedge fund strategies.
This notion has been entertained by recent research conducted by KPMG and the Alternative Investment Management Association (AIMA), which found that hedge funds are preparing to emerge from disruption caused by the coronavirus pandemic more resilient, adaptable and efficient by adopting a “decentralisation of operations”.
KPMG and AIMA surveyed 144 hedge fund managers globally – representing $840bn (€704bn) in total assets – in real time throughout the pandemic to discover how the alternatives sector had performed and adapted to meet the new normal, and how investment funds were expected to change going forward.
The survey found that 71% of respondents cited the success of operating in the current remote working environment as a catalyst to increase outsourcing operational and technological solutions to improve efficiency, generate cost savings and manage margins more effectively.
Andrew Weir, global head of asset management at KPMG International, said hedge funds “are evaluating their existing operating model and adjusting their core processes, cost structures and work environments so they are positioned to grow and meet the changing needs of investors”.
The research study also showed that more than 80% of respondents were investing in their digital infrastructure and IT capabilities. Half of all firms said they were investing in cyber security measures with one-in-three firms saying they were building a central data warehouse to facilitate data analysis and reporting.
“Susbtancial additional income”
Revenue estimates vary, but indicate greater moves to outsourced trading could generate substantial additional income for providers. Established players could look to grow revenue from their existing client base as more services are used and volumes increase, Capco’s paper added.
The co-authors also found that as outsourced trading matures, scale and credibility grows, larger hedge funds, especially with working from home being the norm, could start to outsource more middle office functions.
At KPMG, partner Christopher Mears said the vast majority of emerging managers and otehr investment firms start with the assumption that they will be outsourcing key functions from the very beginning.
“It’s that cost scalability that underpins their business model. Investors understand this and — as long as the managers are able to integrate with their providers — are very comfortable with the approach,” he said.
Providing the outsourced trading service, Capco’s report highlighted, would not be a trivial investment for firms. With a need to establish ‘Chinese walls’ between certain business units, updated policies and procedures as well as IT change would be required.
Large investment banks that provide research, banking, and prime brokerage services in addition to outsourced trading services could potentially be competing/trading against their own outsource trading OT client base, said Capco’s Bennett.
Firms interested in migrating to an outsourced trading model would need help shifting their traditional middle/back office functions to the offering firms, which would require additional resourcing to make it happen, the paper suggested.