Hedge Funds Pay Jefferies to Trade for Them in One-Stop Shopping
Hedge Funds Pay Jefferies to Trade for Them in One-Stop Shopping
(Bloomberg) -- Jefferies Financial Group Inc. is luring dozens of clients to a trading venture for hedge funds, a business that some of its largest rivals exited a decade ago.
The firm has attracted more than 60 clients for the outsourced-trading business it started last June, according to John Laub, head of prime brokerage at New York-based Jefferies. It also hired six buy-side traders for the operation at its prime brokerage.
Jefferies is building the business as hedge funds increasingly move trade execution to third parties. More than 40% of startup hedge fund clients outsourced trading last year, up from less than 10% in 2016, Laub said.
“Managers are looking and saying at the end of the day, ‘What investors want me to do is generate alpha, that’s my No. 1 focus,”’ said Laub, who joined Jefferies in 2014 after working as the finance chief of hedge fund firm Red Alder. “Having to do the trading myself? Not a good use of resources and time.”
Hedge fund launches have slowed, clients are pushing for lower fees and the rise of electronic trading brings the need for expensive high-tech systems. Outsourced trading desks can ease that cost pressure.
Laub likened the business to “one-stop shopping.” Some hedge funds use Jefferies for their entire trading operation, while others delegate only certain activities, such as executing on positions in markets that aren’t open during U.S. trading hours, he said.
Outsourced trading works like this: A portfolio manager comes up with an idea, then contacts the prime brokerage at an investment bank to execute the trades. The goal for the money manager is to get the best possible execution, keep a lid on trading costs and gain some market insight from the brokers.
Large banks like Morgan Stanley used to have outsourced-trading capabilities but exited that business when prime-brokerage divisions were reeling. UBS Group AG, where Laub once worked, had a similar business that it ended before the financial crisis. Now, outsourcing trading is “emerging as a mainstream offering,” according to a December report by Greenwich Associates.
Other firms offering outsourcing include Cowen Inc., which built its business through a series of acquisitions, Jones Trading and Blackstone Group LP-backed BTIG. INTL FCStone Inc. is looking to start an outsourced business.
“We’re going to make a pretty aggressive entrance,” said Doug Nelson, co-head of prime brokerage at INTL FCStone. “The trend kind of started in the smaller managers, and now you’re seeing a lot larger funds outsource some or all of their trading desks.”
Fund managers often don’t think they need traders and try to buy and sell on their own, said Laub. But “very soon, they realize it’s not a full-time job, but still takes up 20% of their time, which is more time spent on trading than they wanted.”
For the largest clients, an outside firm can offer anonymity when placing orders and allow them to get the lowest possible trading costs and negotiate better prices among other brokers. Typically, fees are set by the investment banks, which can charge a couple of cents per trade, rather than reaping a monthly fee.
Almost all clients surveyed by Greenwich are pleased with outsourcing trading activities. Still, the market intelligence firm cited some challenges, including concerns about who’s directing the trades.
“The chief objection is the desire to retain control of their order flow,” the Greenwich report said.
--With assistance from Hema Parmar.
To contact the reporter on this story: Sonali Basak in New York at sbasak7@bloomberg.net
To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl, Alan Mirabella
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