State Street has seen a spike in interest, by fund managers and pensions funds in the region, in outsourcing their trading activities in recent months. The uplift appears to have been prompted by COVID-19 and the aim to reduce risk.
Michele Hardeman, State Street’s Hong Kong-based head of global markets for Asia Pacific, has written an opinion piece on the topic. In that piece she says: “The onset of COVID-19 feeds into, and gives new relevance to, what has already been a growing trend of outsourcing trading activities. In the last decade, asset managers around the world have been facing existential fee pressures from increased competition and the structural shift into index investing. The current low-yield environment and the costs associated with growing regulations adding more cost pressures to asset managers as well as asset owners.
“This has created a need to be laser-focused on the areas where they can truly add value for clients as well as where it makes sense to cut costs. Outsourced trading has enabled them to reduce costs, focus on their core portfolio construction mission and get access to the scale and diverse sources of liquidity of a larger trading operation. They are the architects who design what they want, and their engineers, i.e. outsourced trading partners, execute on it as an extension of their teams.”
The situation for funds and their managers in the Asia Pacific region is exacerbated because they are growing faster than their European and North American counterparts and because they are increasingly allocating to international, rather than domestic, assets – both equities and bonds, as well as alternatives – all of which require a little more effort and oversight. This also puts increased pressure on FX trading and monitoring.
James Woodward, a senior managing director and head of portfolio solutions for Asia Pacific at State Street Global Markets, based in Sydney, says the trend towards outsourcing trading was well underway before COVID-19. But, at any time of heightened risk to elements in a portfolio, such as now, the increased efficiencies and risk-reduction attributes of outsourcing, in general, tend to be of greater attraction to funds and their managers.
Woodward, a 20-year veteran at State Street, both in Australia and overseas, said last week that outsourced trading is a “framework to provide execution facilities”. It has a number of uses and takes on a number of forms, the main three forms being:
- Full service, whereby the provider, such as State Street Global Markets or several other big global banks, act as the client’s inhouse trading team, providing all the same functions
- Modular service, whereby the client retains a trading desk but looks for expertise or efficiency when entering a new asset class or investment geography. As an example, he says, quite a few domestic Australian and New Zealand managers have looked to add international capabilities to their product range in recent years, outsourcing has allowed speed to market as well as the other advantages, and
- On demand service, whereby certain situations may call for a quick additional capability. COVID-19 is one such example, given many people were forced to work from home, perhaps depleting a trading desk’s functionality, or other team issues, or a new demand for overnight trading.
State Street has in recent years moved its focus up the curve for its big-investor clients, to middle office and front-office services, as other big custodian banks have also aimed to do. In 2018 State Street bought Charles River Development, a global financial information company and BestX, a transaction cost analysis specialist. “We want to provide clients with the all of the services to have a full “life cycle” service from portfolio and order management to market execution, through to middle office and custody,” Woodward said.
The New Zealand market, which is not as domestically focused as, say, Australia’s, has also been receptive to the notion of outsourced trading, Woodward says. “The big NZ funds and managers tend to have more of an international focus when it comes to asset allocation given the size of the domestic market,” he said.
For asset owners, especially in Australia, rapid growth plus pressure to merge with other funds, has increased the level of insourced investing in recent years. The funds need to decide whether to provide the operational infrastructure themselves or to outsource it. “There are systems, reporting, compliance, risks, legal costs… I can give you a laundry list of the issues people need to consider,” Woodward said.
From a fund manager’s perspective, we are seeing domestic managers broadening out into international as well as adding other specialties to their portfolios, such as ESG considerations. The trend to boutiques is also continuing, albeit at a slower pace than a few years ago. Start-ups will be looking for lower costs and more efficient trading and other operational functions. “There are a number of elements that come together,” Woodward said.
State Street’s outsourced trading hubs are Sydney and Boston, where there are more than 40 people dedicated to servicing all major asset classes – equities, fixed income, FX and exchange-traded derivatives.