The Life-Changing Magic of Trading Desk Technology
Tidying expert Marie Kondo recommends that when decluttering, one should hold each item and ask, “Does this spark joy?” and if the answer is, “No,” away it goes. For a growing number of asset managers, it appears that an in-house trading desk no longer “sparks the joy” it once did.
Outsourced trading desk providers report demand is on the rise, perhaps an unsurprising trend given that trading desks are capital-intensive in an environment where cost-cutting is paramount. However, with more money moving from active to passive instruments and active managers under increased pressure to perform, a superior strategy to boost performance might instead come from investing in the trading desk itself—harnessing technology that reduces the cost of trading while driving the discovery of alpha.
The approach relies on a shift in perspective, leaning into the concept that the value a trading desk provides goes beyond pure execution, and into the potential for performance generation. It also requires that traders be given more responsibility and more powerful tools to enhance their ability to have greater impact on the investment and trading process. Outsourced trading desks may buy stocks relative to the arrival price, and the numbers may look good initially, but those results fall short of how a trader would have executed had he/she been bolstered by the advantage of sitting next to the portfolio manager and having access to all the information gained through that proximity and mentorship.
Once an asset manager decides to pursue a strategy that focuses on maximizing traders’ unique skillset to help drive performance, the next step is to invest in tools that will not only reduce the cost of trading but also drive the discovery of alpha by allowing traders to reallocate their time. This means employing technology that increases the automation of trading along with analytics that comb through both structured and unstructured data sets in search of market and trade insight. Such tools do not solely benefit PMs and analysts; they would also empower buy-side traders to find alpha in places the PMs and analysts are not usually looking. These sets of tools could ultimately result in enhanced fund performance by helping the entire trading and investment team to access, consume, and react to information faster and with more conviction.
While it’s clear that an outsourced trading desk can deliver short-term cost reductions, the more important question is whether this type of solution can actually help active managers outperform passive funds. In reality, the biggest cost of the trade is the implementation of a trade idea – the amount of time between when PMs starts looking at options to when they actually give the order to the trader. Machine learning (ML) and natural language processing (NLP) can help investment teams reach decisions more quickly, significantly reducing the cost of the most expensive aspect of the trade. We can see a glimmer of this potential when Artificial intelligence (AI) is successfully integrated into algos. But, the true value of AI is when it enables a PM to make quicker investment decisions with higher conviction. In other words, whoever makes the most informed decision the fastest gets the alpha.
It is common knowledge that there has been a data explosion in the past decade, with a tremendous amount of it already in the marketplace and more produced daily. Structured data is delivered every nano-second as a result of trading activity and unstructured data is generated continuously from research shops and corporate communications departments of public companies. The influx of information can feel overwhelming, but with the right technology, it presents a huge opportunity for AI to comb rapidly through the data sets in the search for insight and intelligence.
Not only can investing in technology to support an in-house trading desk potentially lead to alpha generation, performance and cost-cutting benefits, but it is in line with how the industry is evolving, as asset classes become increasingly intertwined. That interconnectivity creates a ripple effect where activity in one asset class affects other asset classes, and as technology develops, those network effects will emerge and change ever more rapidly. The buy-side needs to invest in and stay on top of technology in order to remain competitive.
Finally, there is a cultural benefit to keeping the trading desk in-house. It boosts morale for an asset management team to see the firm invest in its people, a distinction that is even more valuable when the financial services industry is in flux. A common misconception is the idea that technology and increases in efficiency are about eliminating jobs, but the most effective use of technology is to automate things that are predictable, empowering traders to evaluate and respond to the unpredictable in a way that minimizes risk, limits costs, and ultimately increase returns.
The wish to “declutter” in the current operational environment, marred by ever-squeezed margins is understandable. But before eyeing the in-house trading desk as a potential candidate for an outsourcing exercise, it is worth asking if ridding of it will actually achieve the firm’s strategic goals. A better understanding of the evolving role of the trader, and a closer look at the changing fundamentals of the trading desk, may spark joy once more and deliver greater performance for the asset managers in the long run.
Mike Capelli, Head of Equities, Americas
This piece first appeared on HFM Technology