Analyzing the growth of outsourced trading

Key Takeaways

• More asset managers are choosing to outsource their trading desks
• Reported benefits include improved performance and reduced costs
• Some firms are reluctant to relinquish trading control to a third party

More than nine out of 10 (91%) fund managers expect to increase their use of third-party service providers over the next 12 months, with 41% anticipating a dramatic increase.

This was a finding from a 2024 Carne research report that surveyed 201 fund managers responsible for USD 1.6 trillion in assets under management. It demonstrates the extent to which external pressures are driving a change in business models.

Most significantly there is a clear trend towards outsourced trading (OT) desks. Once considered taboo, a Coalition Greenwich study of asset managers published this August reveals that 10% have paid trading commissions to outsourced trading platforms over the past year.

Not only are asset managers paying third parties to execute trading, but those sums are not insignificant. The study, based on responses from 103 buy-side equity traders globally in the fall of 2023, found that 7% of respondents paid commissions to OT providers ranging up to USD 3 million, while 3% paid more.

And it is not just small or under-resourced managers who are taking the leap to outsourced trading; Coalition Greenwich said it spoke to “several large and well-established managers who have also embraced the idea.”

But as Jesse Forster, equity research lead for the Market Structure and Technology team at Coalition Greenwich, says: “This finding may raise eyebrows, as the buy-side has traditionally been hesitant to admit to using such providers due to concerns about cannibalisation and compatibility with best execution requirements.”

Outsourced trading’s multiple benefits

Where before asset managers were unwilling to concede that their own trading desks required supplementary support, there is a growing disposition to accept that third parties do more than just plug execution gaps.

A survey of 300 institutional investors published by State Street this April reveals multiple benefits to adopting an outsourced model, which proponents believe enhances their execution efforts:

• More than half (55%) of current users of outsourced trading report increased efficiencies, while one-third say they have experienced reduced costs.
• Four-fifths say they have seen improved investment performance and 32% say they have more access to trading talent.
• Among the 55% citing increased efficiencies, 70% reported enhanced risk management from outsourcing, while 54% enjoyed streamlined post-trade reporting; 42% saw faster trade execution, and 42% reduced their administrative burden.

These are significant and material positive impacts of outsourcing and explain why even asset management behemoths are choosing to move at least some of their trading to a platform.

As the State Street report notes: “Outsourced trading has evolved from a practice pursued by smaller investors lacking capacity or expertise, into a strategic offering that can bolster and enhance the operations of firms of all sizes.

“Outsourced desks allow international funds to remain focused on portfolio management and generating alpha while gaining access to scale, insights, liquidity and technology.”

Cautious start

Given the suspicion with which outsourced trading has been viewed, it is no surprise that early adopters have chosen to merely dip their toes in the water rather than fully immerse themselves in the model.

The State Street survey reveals that eight in ten asset managers leverage outsourced trading for just one or two asset classes, with fixed-income emerging as the most popular choice for an external desk followed by foreign equities, derivatives, FX and domestic equities.

Early adopters report high levels of satisfaction with their outsourcing providers with 79% saying they are either “satisfied” or “very satisfied.”

It’s no wonder expansion plans are afoot. State Street research finds a “clear trajectory toward greater outsourcing across the board,” and providers are likely to “move in step with this demand.”

Asset managers are likely to lean on trading platforms for support with more complex asset classes, such as derivatives and swaps, while access to 24/7 trading through a third party makes it easier to trade FX and foreign equities.

Overcoming hurdles

However, the clear trajectory to greater outsourcing comes from asset managers who are already converted. Convincing those who have yet to outsource that they should get on board may be more challenging.

Respondents to the Coalition Greenwich research questioned how outsourcing impacts trading discretion, with one buy-side head describing it as “the most perishable thing”.

The concern is how outsourced desks could preserve the flexibility of discretion in the same way internal desks can. Further, some asset managers believe that only in-house traders, in continuous contact with their portfolio managers, can build real relationships and earn discretion around how they trade their orders.

State Street notes similar reservations from those yet to move to outsourcing, sharing additional concerns about costs and control.

However, the report’s authors say such matters are immaterial to current users, arguing these objections about outsourced trading “are not warranted”.

While outsourced trading is undoubtedly gaining traction, not every asset manager is keen to give up on their core discipline. For platforms to gain a bigger market share, they will need to convince the market that they supplement in-house trading rather than supersede it. For asset managers, it’s critical to partner with trusted global vendors.