The COVID-19 pandemic is adding fuel to the fire of interest from some fund management firms in outsourcing the execution of their trade orders to third-party specialists.
Over the past few years, fund managers have decided that outsourcing isn’t only for middle and back-office functions. It can also be used for trade execution with cost reductions coming from the provider’s scale and expertise coming from more skilled traders who have previously worked in sell-side firms. The COVID-19 pandemic simply added at least two more immediate factors to the decision-making process for what has been called the third-wave of outsourcing– disaster recovery and acceptance of working from home. “The what-if scenarios have become significant and this pandemic has forced investment managers to evaluate their business continuity plans. Buy-side traders could easily become sick or unavailable,” says Packy Jones, executive chairman of JonesTrading, a Westlake Village, California-headquartered broker-dealer offering outsourced trading services. “Portfolio managers also realize they don’t have to be working in the same office as their traders to be successful.”
As if the growth of exchange-traded funds, passive investment strategies, and low-cost strategies weren’t hard enough to squeeze most fund managers’ profits, the pandemic has made it even harder for them to retain their thin margins while fulfilling regulatory requirements. “The implicit cost of trading has risen substantially during the pandemic as market volatility rose and access to liquidity became difficult,” explains Tim O’Halloran, managing director of Stamford, Connecticut-headquartered broker-dealer Tourmaline Partners, which also offers outsourced trading services. Having access to more pools of liquidity than the average buy-side trading firm, service providers can help fund managers meet their “best-execution” obligations for orders to be executed at the lowest total cost — implicit and explicit. Implicit costs are higher to calculate than explicit, which are the actual brokerage fees for trade execution. Implicit costs include the bid-ask spread, market impact, and arrival cost or the difference in the price of the shares from the time the order was placed by the client to the time it was executed.
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