Surf’s Up Bro: Catch the “Third Wave of Outsourcing”

Close up of surfer riding wave

Back in December 2018, I wrote a blog about a relatively new trend that seemed to be getting some traction: outsourced trading. The concept of outsourced trading wasn’t brand new at the time and there had been limited talk of offerings in the investment operations outsourcing space—specifically from the custodian banks. Fast forward to now and it is a hot topic in asset management and part of a larger trend of front to back service offerings, as discussed in our Outlook 2020: A New Frontier in Asset Management.

Northern Trust, who has not been shy about talking about their offering, is calling this trend the “the third wave of outsourcing” (the first and second being back and middle office, respectively). But Northern Trust isn’t the only provider touting their offering or talking about outsourced trading—BNY Mellon, State Street, and others are also expanding to the front office. Seems like every other day I see a reference to it in the news feeds of the various industry publications.

In our industry conversations, we see there is still some skepticism around the concept, specifically in North America; but as history has shown us, when more firms adopt an outsourced model, we see the target market and interest level expand. One service provider claimed in a recent conversation that they were surprised by the uptick in interest and specifically from “a large $500B+ asset manager.” A year ago, it seemed like this was an offering geared towards two types of clients: 1) startups who didn’t want the burden and cost of standing up a trading desk, and 2) asset owners who were previously externally managed and were looking to bring some (or all) asset management in house. The commercial model feels like the most logical driver for a smaller firm, startup, or asset owner but interest from a large asset manager (especially the $500B+ size) would have to be driven by more than cost savings. Simplification and a desire to eliminate functions that are not focused on core competencies definitely come to mind as a plausible rationale for the larger managers.

Not only is the target market expanding but the number and types of providers offering the service are multiplying as well. I recently read a Bloomberg article announcing that Alliance Bernstein is beginning to offer an outsourced fixed income trading service, as well as derivatives, to other buy side firms. Why is this news? Well, to date the outsourced trading market has been serviced largely by sell side firms and service providers, not to mention a predominant focus on equity and FX trading. Russell Investments is also marketing an outsourced trading offering. According to a video on their website they “specialize in fixed income, equities, derivatives, and foreign exchange transactions.” It will be interesting to see how well the buy side adopts a model where their potential competitors execute their trades for them. Best execution will always be a source of trepidation, but I expect potential clients will be concerned over conflicting interests and will need reassurance (and proof) that ethical walls exist to safeguard against competing interests.

Though our industry has a reputation for moving slowly, changes in the service provider landscape that portend the “fourth wave of outsourcing” (more on this here) and the uptick in interest from larger managers may push the market to evaluate trading competencies sooner. That said, just as some firms will question how much value their trading function brings, others will maintain that trading is a differentiator. Riding the wave isn’t for everyone but for firms looking for a trading partner, surf’s up.