As more investors become comfortable outsourcing functions to third-party providers, the importance of excellence in this space is coming into sharper focus. In a part of the industry where services can risk becoming commoditised, providers are keen to demonstrate the high calibre solutions they offer. Outsourcing can alleviate a number of pressures off investment managers, however the service provided needs to be of the highest quality.
Jack Seibald (pictured), Managing Director and Global Co-Head of Prime Brokerage & Outsourced Trading at Cowen, has closely observed the industry’s development. He comments: “The most important lesson the outsourcing industry has learned is that the solution offered absolutely, unequivocally needs to be of a calibre that will meet, and even exceed, the expectations of investment managers. This means the work product must be top-notch, but also needs to come a cost that is reasonable and materially less than the cost of replicating the solution internally.”
Several trends have been emerging which have led to service providers raising the stakes when it comes to their provision of solutions and resources.
Institutional investors have grown increasingly comfortable with the concept of outsourcing by fund managers of non-investment related functions, including middle and back office support, COO/CFO functions, compliance, and trading.
This is driven by the notion that fund managers are best left to focus on their core competencies in security selection and portfolio management. In addition, the trend is supported by demonstrated high-calibre capabilities of the firms which have developed offerings in their respective fields over the past five to 10 years.
Investors are beginning to understand that the skills required to manage an investment management business are quite different from those deemed necessary for effective active portfolio management. Seibald elaborates: “Any efforts expended by portfolio managers on the former are potentially a distraction from where their complete attention should be dedicated. We’ve also been hearing with increasing frequency that allocators appreciate that another independent set of eyes are trained on the activities of fund managers, which potentially adds another layer of checks and balances on their investments.”
The elevated role of outsourcing is being integrated into the industry as newly launching funds are opting to outsource their non-investment related activities. According to Seibald: “In our experience with newly launched funds over the past year, building internal teams for trading and operational support was very much the exception, as the overwhelming majority elected to outsource at least some functions.”
He says this was particularly true of new launches by highly pedigreed managers that launched with sizable assets, suggesting the trend has reached a broader audience.
More surprising, notes Seibald, is the level of interest in and adoption of outsourcing solutions demonstrated by well-established, traditional long-only investment managers. “Not immune from the same trends impacting hedge fund managers – underwhelming relative performance, competition from much lower cost passive strategies, and compressing fee structures – these firms are increasingly looking to cost containment/reduction efforts,” he outlines.
Drivers beyond cost
Cost has been the principal driver of the outsourcing trend for some time and the potential savings from engaging outsourced service providers can be quite meaningful to firms.
However, other dynamics are playing an increasing role in the decision-making process around choosing to outsource. For example, other than perhaps the largest and most well-funded organisations, most investment management firms are not likely to have the capacity and resources to hire a team to rival those being offered by outsourced providers.
Further, the calibre of the service providers offering outsourced solutions has also been enhanced. “Whether it’s the middle and back office service providers, the outsourced COO, CFO, CCO firms, or the outsourced trading desks, the common thread among them is the backgrounds and experience of the personnel providing the solutions,” Seibald points out.
Another key element outsourcing offers is flexibility. Seibald explains: “If and when firms decide to make a change, whether it’s to a different service provider or to building out the infrastructure internally, doing so can be easily achieved. And finally, and most importantly, outsourcing non-investment related functions affords portfolio managers the opportunity to remain laser focused on security selection and portfolio management, and avoid being distracted with managing internal personnel and infrastructure.”
The penetration and uptake of outsourcing arrangements have also been buoyed by regulatory developments. MiFID, with its mandated unbundling of research and execution commissions, has played directly into the services provided by outsourced trading solutions.
According to Seibald, this service gives clients the ability to separately negotiate the costs related to execution services and utilise outsourced service providers to manage all elements of the transaction from execution to settlement.
Outlining Cowen’s specific growth path, Seibald acknowledges the broadening acceptance of outsourcing among investment managers, and of those investing with them, has been a material driver of the firm’s progress over the past year.
“Our Outsourced Trading service, which encompasses a comprehensive set of solutions beyond just trade execution, expanded significantly as we added personnel across the globe and onboarded many new clients,” he notes.
In terms of personnel, Seibald believes this is a principal challenge for any firm offering outsourced solutions: The service one provides, regardless how well articulated, designed and intentioned, ultimately depends on the quality of the team delivering that service.
“We developed our differentiated outsourced trading solution over many years, and throughout that time continued to invest in people and the technologies needed to support them and our clients. We made a decision quite some time ago that our solution needed to truly function as a buy-side desk, not just in our minds, but in our clients’, if we were to be effective in helping us to achieve our goals and objectives.”
This led to the firm significantly expanding its team of traders with demonstrated experience working directly with portfolio managers on the buy-side.
Regarding the firms’ new business success, Seibald notes: “While the majority of new client wins over the past year were new fund launches by managers that had spun out of large fund platforms, we began to see interest from existing funds who were exploring outsourced solutions to supplement their internal trading operations or completely replace them.”
Jack Seibald
Managing Director, Global Co-Head of Prime Brokerage and Outsourced Trading, Cowen Prime Services
Jack Seibald is Global Co-Head of Prime Brokerage and Outsourced Trading, Cowen Inc. He was a co-founder and managing member of Concept Capital Markets, LLC until its acquisition by Cowen Group, Inc. in September 2015. He has been affiliated with the firm and its predecessors since 1995, and has extensive experience in prime brokerage, outsourced trading, investment management, and research dating back to 1983.
