By Andrew Walton, Head of European Business, Tourmaline Partners
The institutionalization of the Family Office (FO) has been a key trend in recent years. Historically, FOs have gained exposure to global markets via investments in hedge funds, private banks and wealth managers. Amid diminishing returns tied to high fees, many of them have taken steps to bring this investment expertise in-house. Combined with the overall growth of the FO space in recent years – a 2019 report from Campden Research found that the number of FOs in Europe had grown by 32% from 2017 – it is fair to say that FOs are more active in global markets than at any time before.
The problem is that while FOs may relish the chance to forge their own path, building capability for direct investing into global listed companies, they are running into the same problems that plague the buy side at large. Technology and compliance costs are rising rapidly, making it steadily less economical to build and maintain in-house capabilities such as trading. Furthermore, it can take years to build a trading desk with enough experience, connections and resources to compete in today’s markets. While larger managers may be in a position to address some of these challenges, FOs are disproportionately affected because they do not have the reach or size to benefit from any economy of scale.
FOs are constantly looking to their peers for ideas to help maximize efficiencies and optimize, among other matters, their wealth strategy and investment operations. The FO space tends to be characterized more by an ethos of collaboration and collective best-practice than one governed by competition between families. The unique construct underscores the reasons for the existence of FOs. Wealth preservation, financial security, continuity and succession are the drivers; education, discretion, trust and confidentiality provide the governance.
In terms of optimizing their investment operations, FOs are also looking more broadly to what others on the buy side have done by leveraging tools such as outsourced trading. Buy-side players of all sizes and descriptions are realizing they can avail themselves of this model to significantly expand their reach and capture operational efficiencies. The exponential increase in access to information, liquidity and pricing results in huge cost savings, at the same time opening the door to rapid growth. In a November 2020 survey of heads of investment operations from global asset management firms by Acuity Knowledge Partners, 85% of the respondents stated that they had already adopted outsourced trading or were interested in doing so, a level of interest that has been accelerated by the pandemic and the associated volatility and business continuity concerns.
While taking advantage of the right outsourced trading solution has always offered benefits to a variety of capital markets participants, the effects are especially pronounced for FOs. With the excitement around large managers turning to outsourced trading in the past few years, it is easy to forget that in many places the business began as a niche service for hedge funds at launch. The industry has since exploded and now serves buy-side firms of all sizes, including large institutions looking to supplement their own sophisticated trading desks, but it continues to have transformative potential for smaller players as well.
One key reason is that outsourced trading enables greater scale and provides much greater access to the sell side. This is a key factor because of the almost perfect correlation among sell-side access, cost reduction and enhanced investment performance.
An FO may only have the budget to hire one, possibly two, traders in one geographical region, but a truly sophisticated buy-side desk requires a larger operation. The staff must be highly experienced – not only to ensure that the desk can manage the right number of sell-side relationships, but also to maximize the expertise required for everything from navigating global volatility events to buying and selling illiquid shares. In addition, many large desks have an on-the-ground global presence, ensuring that the quest for alpha is not interrupted by the human need for sleep in any one region.
By working with an outsourced trading firm, FOs are achieving a level of scale and reach that would be impossible to replicate themselves. Instead of being seen as a single, relatively small voice in a massive buy-side landscape, the FO is represented by an institutional-grade provider with a global footprint. The scale that is gained by the outsourcer in servicing a large pool of clients, in turn allows access to the best sell-side tools, liquidity and market intelligence paving the way to cost reduction, best execution and enhanced performance.
In addition to increasing scale and reach, outsourcing ensures that FOs maintain complete anonymity in their trading. While the FO space can be diverse, an overriding theme is the need for absolute discretion. High-net worth, often prominent families do not want to tip their hand or have their every move scrutinized when it comes to global markets. Allowing a partner team of experts to trade on their behalf allows FOs to be discreet while maintaining full control over their assets.
Needless to say, not all outsourced trading firms are created equal, and identifying a fully independent provider offering a pure-play buy-side trading experience is crucial, especially for FOs. This contrasts with more recent offerings from sell-side brokers and custodians. An agnostic, unconflicted approach means there is no leakage of information. The sell side has absolutely no insight into client order flow – which is not the case when interacting with many of the other sell-side or hybrid providers. The FO investment strategy is, and should remain, part of its intellectual property. The existence of so many contrasting offerings means due diligence is crucial.
Keeping these factors top of mind will continue to serve FOs well as they evaluate the various providers of outsourced trading solutions. In a world where scale, reach and anonymity have become precious commodities, the independent outsourced trading model offers a path to bypassing the enormous cost and arduous process of building a global trading desk. FOs can focus on maximizing returns and keeping costs low. The buy side at large is undergoing this shift, and family offices are following suit. The benefits are exponential and well worth exploring.