The hedge fund industry is starting to witness a growing trend in outsourcing front-office trading desk operations. Start-up hedge funds in particular benefit from outsourcing if they lack sufficient capital to build out their own in-house trading desk, and this appears to be especially true of Asia where the size of hedge fund start-ups, generally speaking, remains small.
To capitalise on the trend, BTIG Hong Kong Limited, an affiliate of BTIG LLC, has been busy getting its outsourced trading desk message out to emerging managers, with the firm’s Executive Director, Trevor Harrison (pictured), confirming to Hedgeweek that “probably half of the business in the last 12 months has been start-ups and we’ve already seen a good number this year”.
BTIG expanded its Global Outsource Trading team into the region when it opened a desk in Sydney, Australia at the end of 2009 and even though BTIG Hong Kong Limited ‘officially’ announced its outsourced trading solution in August 2011, Harrison is quick to point out that the firm has always had an outsourced desk.
“When we expanded out of the US the outsourced desk in Hong Kong was looking after equity flow coming into Asia from hedge funds based in the US. The change in the last couple of years hasn’t been in opening the desk per se, it’s been in providing the service to local managers instead of just those trading into the region. We took on our first Asian client last year,” says Harrison.
In addition to Australia and Hong Kong, BTIG has a desk in London and two in the US: New York and San Francisco. The major benefit to using outsourced trading, aside from the cost efficiency, is if you’re a fund trading a global strategy, say out of Connecticut, but lack a trading team in Europe or Asia. And as middle-office functions are being more and more outsourced to their administrators, so managers are increasingly starting to look for front-office support to avoid having to hire additional trading teams.
Harrison is quick to point out that outsourced trading is not attempting to replace the trading function in a hedge fund but rather augment the process. An Asian start-up might have a couple of Asia-specialist traders but not necessarily those with the same trading expertise in US/European equities.
“When you hire us you’re hiring physical traders that trade the markets every single day. Clients hire us in addition to their existing systems – they have their own portfolio management systems, order management systems etc. With any outsourcing solution, it comes down to deciding ‘Can I do this better myself or am I better off using a specialist’?”
Of course, outsourced trading isn’t for everybody, but with the barriers to entry even higher and the need to demonstrate operational robustness from Day 1, the days of two traders, a garage and a credit card are long gone. In Asia, there has been an awful lot of natural wastage over the last few years; many small hedge funds that existed prior to the credit crunch lacked first-class infrastructure and soon disappeared. Last year saw 123 closures in the first 10 months alone according to Eurekahedge. So has the mindset of start-ups changed, and is this playing into the hands of oursourcers like BTIG?
“Certainly managers understand that they need to have a first-grade operational and trading infrastructure from day 1 and they’re taking more time at launch so that they can attract institutional money. We see ourselves as part of this essential infrastructure, helping managers to get up to speed. With any outsourcing service, it’s easier to engage with someone at inception before they’ve put all the pieces in place. We see no shortage of start-ups but many clients are existing firms where engaging BTIG can plug gaps in a legacy trading process and improve overall execution,” comments Harrison.
Eric Morgan, senior partner and head of trading at Merlin Securities who themselves offer an outsourced trading solution, says that whilst the OTD is most popular amongst US start-up hedge funds “at the same time, however, we have multi-billion dollar money managers using our trading desk for our expertise and technology”.
Another helpful aspect is that hedge funders aren’t stymied be their existing in-house trading systems when they choose to outsource. BTIG, for example, uses Fidessa for its OMS but is able to plug and play into most of the main technology groups (Eze Castle, Linedata, Paladyne etc) used by clients.
Although Hong Kong start-ups looking to control costs at inception are a natural audience for outsourced trading, the audience is wider than that. Harrison says they fall into four buckets. Firstly, the new guys who want a first-class trading desk without having to build systems and hire their own team; secondly, the guys running existing funds but who are expanding into different markets and don’t want the burden of opening an overseas office; thirdly, funds that have been hit by redemptions and have chosen to outsource to reduce overheads; and fourthly, funds that choose outsourcing as part of their business contingency plan.
“Investors want to see what a fund manager’s back-up procedures are, not just in middle- and back-office operations but trading as well. What happens if you’re a small fund with a couple of traders and one of them quits? What happens when they go on holiday? So they use as part of their contingency,” explains Harrison.
As for what hedge funders need to think about before going down the outsourced trading path, Morgan says: “They need to look at the experience of the traders working their orders and understand the technology and work flow that the OTD will use to clear and settle their trades. The last thing a fund manager wants to deal with is allocations and trade breaks.”
Outsourced trading desks simply follow the trades through from start to finish. They trade out to the brokers selected by the client and have no say on the price which will have been set by both parties. Prior to initiating the trade, a commission rate between the client and the outsourcer is agreed. Logically, the higher the trade flow the more favourable the commission rate.
As for future opportunities, Harrison says that in the US the firm is already supporting managers running advanced strategies in fixed income, futures and options aside from equities and notes: “In Asia the market is still equity-focused and that remains our core client base but as the market evolves here it will create new opportunities.”
BTIG currently has approximately 14 staff on its trading desk, all of who are Asian equities specialists.