For all the talk of outsourced trading, optimising internal trading technologies and workflows remains the preference for many Australian asset managers, the 4th Investment Implementation Summit has heard.
However, less optimal trading practices continue to cause a significant drag on performance, making it more important than ever to maximise internal workflow efficiencies.
Citing new research, David Rogers, partner at Quinlan & Associates and former Head of Trading at SSGA, told conference participants that inefficient trading practices are causing buyside trading desks globally to potentially lose 1.2-2.7% in fund performance for their end asset owners. In economic terms, this can translate to up to USD 18 billion in lost performance for the largest funds.
While separate wastage can incur from the explicit costs inherent in running a trading desk, which asset managers themselves bear, the more significant leakage stems from these implicit trading costs, with a lack of technological proficiency, poor choice of execution methods and a lack of partnership and collaboration with clients, portfolio managers, traders and brokers of particular concern, Rogers said.
“If you are in the currency or fixed income space, perhaps it’s not using Request for Quote (RFQ), Request for Stream (RFS) technology, or maybe if you are in the equities space not using an Electronic Crossing Network […] but the really critical problem facing buyside trading desks is [the fact that] most buyside trading desks still operate largely within a bubble in a siloed mentality, away from clients, portfolio managers and sales teams, or not fully utilising broker expertise,” Rogers said.
Indeed, the research, which was released on Monday, estimates that traders using inappropriate algorithms can cause can cost 30-50 bps p.a. in aggregate, unobtained fund performance in a typical year. An additional 50-60 bps p.a. may be lost in the case of a robust, systemised workflow not being deployed for liquid or semi-illiquid execution, while not using an ECN, RFQ or blocks desks for illiquid or block crossing may result in 200-300 bps p.a. worth of implicit opportunity cost.
Suboptimal trade execution methods result in a further 20-30 bps p.a. of implicit costs, for example when traders resort to high touch methods where an electronic solution could have been deployed, but it’s a lack of collaboration and transparency with partners – whether they are core brokers, clients or internal stakeholders such as portfolio managers – that hurts the bottom line the most, resulting in as much as 700 bps p.a. being lost.
To optimise or to outsource
Reducing slippage was a key theme throughout the conference, which focuses on investment implementation efficiencies from investment strategy through to execution. According to Rogers, for most sizeable fund managers, that requires optimising internal technologies and workflows- rather than outsourcing the trading function to a third-party provider.
“Whilst for sure the cost problem is really solved for via outsourcing, we found that optimisation solved for the thing which actually mattered more to the end asset owner which is client engagement and execution quality,” Rogers said. The research found that for a number of reasons, including reduced pricing power on the part of outsourced trading firms, execution quality tends to diminish when transacting through an outsourced trading firm.
Indeed, for many conference participants, the benefits of having portfolio managers and traders under one roof remain too significant to externalise.
Sam Willis, Senior Trader at Dimensional Fund Advisors said that the integration between portfolio management and trading is key to the firm’s alpha generation process. “At Dimensional, the integration between research, portfolio design, portfolio management and trading is what we consider a true value add. I don’t think an outsourced trading desk could be embedded within that investment process to the same degree as an insourced trading desk, but certainly for other managers with other objectives there could be a place for it,” Willis said.
At IFM Investors, the trading function also plays an integral part in the value-add process, Lounarda David, Chief Operating Officer at IFM Investors said. “Operational alpha is becoming more and more important, including the ability to get best execution which isn’t necessarily the cheapest price where there is significant market impact cost, especially for strategies such as small caps and active management. You can’t really outsource execution when it is such a critical part of your value proposition,” she said.