By Simon Broch, AlphaDealing – Arguably, the Trading Desk is at the heart of the investment manager. Why then do so many new start-ups not invest in a dedicated trading desk?
The answer is twofold. Usually, the start-up PM underestimates the skillset required, believing they can give simply give orders themselves, although they will overpay on commission and often receive questionable execution. This is a form of outsourcing the trades, but at an exceptionally high frictional cost per trade.
The second reason, is cost. A manager on a 2/20 fee structure has a lot of expenses to pay in the pursuit of alpha. The cost of the office, the hardware, the outsourced IT not to mention the Bloomberg and live market data that doesn’t seem to really comprehend the concept of economies of scale. As such, how can the PM stomach a cost of atleast $250,000 for a trading desk function? This investment will buy him one junior trader with all the basic systems required to execute during one geographical region. The larger investors will want you to have another trader to avoid key man risk.
This cost factor gave rise to the traditional “Outsourced Trading Desks” which often charge a commission per trade, but eliminate the requirement for an in-house trader. Sounds great, but the commission they charge doesn’t reflect market rates when compared with banks DMA pricing structures. Additionally, you then have a trading desk that is the opposite side of the trade, also known as a broker! Don’t expect your PB to be happy that you have outsourced all your execution to a third-party who they will see as “stealing their flow and commission” and will punish you when it comes to access to analysts, ECM allocations and increased settlement charges.
My view of the future of a trading desk is a little more palatable. As a former Fund Manager of a start up hedgefund, I understand the importance of a good quality Trader. I also understand the importance of directing commission to the banks who will reciprocate with their various services that the FCA would rather you didn’t mention.
Taking all this into account, I set up a totally new model for pricing the desk. By charging a fixed flat fee to the manager for use of a highly qualified team of traders covering all time zones, each fund can benefit from a centralised dealing desk similar to a bulge bracket investment manager. Instead of being the opposite side of the trade, we are approved to set up trades between the investment manager and the investment bank, thus helping to develop the relationship and not be seen to steal it or stand in its way. Furthermore and the banks/brokers like this part, we believe the commission is the property of the broker. We don’t take any part of the commission as we are not the counterparty. You pay a fixed fee for use of our Trading infrastructure, the com all goes to where it will buy something the Investment Manager can use.
If the FCA gets its way and MIFID 2 does transfer the cost of research to the Investment Manager, rather than the fund, the 2/20 fee is going to be getting a pretty hefty additional bill. This means costs will need to be reallocated. My view is that this should be from the trading desk which has the highest fixed costs of all functions, but with the largest underutilisation. Allowing Alpha Dealing to manage your trades will free up a lot of revenue which can be reallocated elsewhere, whilst ensuring the Investment Manager is getting the best execution managed by experienced Traders.
If you would like to discuss the above or receive further information regarding Alpha Dealing, please contact Simon Broch at [email protected]
