Stewart: Should you be outsourcing your fixed income trading? What are the real costs of trading? What about market access? That's the topic of the day. This is the Insurance AUM Journal podcast. My name is Stewart Foley. I'm your host, joined by Meghan Siripurapu of Meraki Global Advisors. Welcome, Meghan. How are you doing today?
Meghan: Hi, Stewart. Thank you very much for having me this morning. I am doing well. How are you?
Stewart: Good, thanks. I'm thrilled to talk about this. I really think this is an important topic. I think that the costs of trading are not really understood. I think we're going to learn a lot today. Can you just quickly tell us about your background and how you came to your firm and how your firm started? And give us the lay of the land of your background a little bit.
Meghan: Sure. So I'm currently the head of fixed income and credit trading at Meraki Global Advisors. We are an outsourced trading company that operates in 25 different global markets in the world. I began my career at Citi in New York where I worked in investment banking. I worked in debt origination, syndicate and then sell-side trading.
Meghan: After that I moved over to Loomis Sayles where I was a corporate bond trader for the last six years. So now I've joined Meraki, which as I mentioned, is a global outsourced trading company that is expanding in the fixed income markets. So I am leading this initiative at Meraki.
Stewart: And Meraki is a pretty young firm, right?
Meghan: That's right. So Meraki has been in existence for about two and a half years. It started in equities but has now expanded to many other asset classes and many markets, including fixed income. So we decided to expand in the fixed income markets because we saw a lot of demand from our existing clients who were either trading in one market and looking to expand into other markets or in one asset class and looking to expand into other asset classes. That's how the conversations originally started.
Meghan: And after I joined Meraki, I've realized that there's so much more opportunity in the fixed income markets than just our existing client base. There are a lot of investors in the fixed income markets who can benefit from outsourced trading, whether they are predominantly trading mortgages and looking to get into credit, or they are trading in the US markets but would like to trade Euro and Sterling credit.
Meghan: We also have a lot of clients who are wearing multiple hats. So it is a portfolio manager who is also doing the execution, or a credit analyst who is also doing the execution. So by outsourcing your trading, these clients are able to focus on what their core competency is, whether it is portfolio management or credit analysis and outsource their trading to someone who is an expert in the area.
Stewart: So when you and I met, that's what we talked about. Right. And just to be completely transparent, I had never considered outsourced trading and I didn't know that anybody did. Right. So before we get too far ahead of ourselves, what is outsourced trading?
Meghan: Sure. At its very core, outsourced trading is using a third party provider to do your trade execution. So on the one end, outsourcing your trading could completely replace your in-house desk. So the trader talks directly to the portfolio manager and the trade settles like it normally does, but you don't have your own trading infrastructure.
Meghan: Another option is to supplement your existing desk. Similar to the example I had given you, when you have one trader who's trading multiple asset classes or multiple markets, you don't want to have a trader who's staying up all night trading in the Asian markets or someone who's located in Asia trading in the US markets. So what you can do is you can outsource the specific part of your trading operation.
Meghan: And the other use for outsourced trading is if you are a new entrant in the market, whether you are just beginning to start trading and you don't want to develop your own infrastructure yourself. You can outsource your trading to someone who is an expert in the area while you are figuring out a lot of the other aspects of running your own business.
Stewart: So you work with both asset managers and directly with insurance companies. Why would someone outsource their trading? Right. We've talked a little bit about, costs are difficult to determine in the bond market and also there's access to markets, particularly if you're not the largest player.
Stewart: So why do people outsource the trading function? Because it always seems like when people outsource they feel like they're losing control somehow like, "I can't let go of that." Right? But there's good reason, so can you talk a little bit about that?
Meghan: In the current environment that we're in, asset managers particularly are seeing margin compression and fee pressures, both insurance companies and asset managers are also facing a lot of cost pressures overall in their business. So they're looking to outsource different aspects of their operations in general. When you outsource trading, you're converting a fixed cost to a variable cost, so you are paying for the services that you use.
Meghan: So if you were an infrequent trader or your trading is even concentrated over small periods of time or you have a low turnover, you're only really paying for what you use. Managers like this aspect of outsourced trading. Also, what I think is probably even more relevant to the fixed income universe is the access to the markets. I have seen over my career, a change in the fixed income markets in general. And this is probably over the last decade and a half.
Meghan: Large investment banks are focusing on their priority clients. So the large investors in the market, whether they're asset managers or insurance companies. And this is where the majority of their attention goes. There are a lot of small companies, insurance companies and asset managers, small to medium size, who don't get the same access to the markets. And this is not necessarily even in trade execution, but it is just color and dialogue and knowing what's happening in the markets.
Meghan: And in fixed income, this is an incredibly important part of trading and executing. It is knowing the markets, the pre-trade analysis that happens before you actually execute a trade. By outsourcing your trading you're able to leverage our network, our brokerage network, our knowledge and our relationships.
Meghan: So when you combine this aspect of outsourced trading with your existing broker network and your existing relationships, you are able to achieve a more well-rounded execution for your trades because you're able to use both. So if you don't necessarily have relationships at a specific bank, we are able to make the introduction and to help open doors so you can access that liquidity.
Stewart: And on top of that there's also... I mean, there's only so many hours in a day, right? So what about other currencies, other parts of the world, markets that trade overnight, U.S. time? Are you accessing those markets as well?
Meghan: That's right. That is something that we do. So we are able to transact in any market in any asset class. And we don't necessarily staff our traders for any account that comes up. Once we onboard a client, we are finding traders that specifically meet their needs. So we don't really have one individual who's trading all asset classes or even all markets is difficult, but we have someone who is specifically an expert in U.S. credit.
Meghan: We'll have someone who's an expert in Euro credit and EM credit, for example. So you are not only able to access those markets, but you're working with someone who is specialized in those markets. So that said, a big part of the business and opportunity is if you are an insurance company who's located in Europe and you see an opportunity just based on where global yields are right now., you see the opportunity in the U.S. market, but you're not looking to work these ridiculously long days which at times could be 16, 18 hours.
Meghan: So what you can do is you can outsource your U.S. trading. You don't even actually have to outsource the whole thing, you can outsource even a portion of the day. So you're able to access the market in real time during the U.S. hours, and also access the knowledge and expertise of a trader whose expertise is in that market.
Stewart: I think it's, and the fixed income world is my background, and I think it's maybe not yet understood by all markets how important the relationship is between the buy and sell side trader. Those are close relationships, and it is an over-the-counter market. It's not like entering a trade for shares of Apple or IBM. This is a very different market.
Stewart: And those relationships matter. I mean, they really do. I mean, it's like how old are your kids and whatever. I mean, you get to know these people. I mean, we were on the phone with these guys every day. But you kind of touched on this, it's not an all or none deal. Right. You can outsource all of your fixed income trading, but you can also outsource a portion of it. And so, can you talk a little bit about the different models of outsourced trading?
Meghan: Sure, I can. So there are multiple models. The one is a prime broker or a custodian model where the executing outsourced trading firm is associated with a prime broker. And usually wherever you do that or your custodian is, is that who you execute with. The other is an agency model. And this model is where an outsourced trading firm sits between the end client and the investment bank. And the insurance company, who's the end client, will face the outsource trading firm and the outsource trading firm will face the investment bank.
Meghan: The last model is a purely standalone model, which is unconflicted, and they can really act as the authorized trader for the end client. And this is a model that Meraki has. So what we do is we act on behalf of our client. So for the insurance company, when transacting with the bank, and you are able to leverage existing broker networks as the authorized trader.
Meghan: So work the relationships that are already existing and help continue to build these as you're building your own business, but also leverage our networks and our relationships. Because as you said, trading fixed income is a very relationship driven business. Although we have seen an increase in electronification, which I think that there's definitely a place for and very important in the market.
Meghan: The bulk of transactions, particularly larger sized transactions happen by picking up the phone, sending a message, having that existing relationship. So as a trader, you are still on the phone all day long with the banks finding out what's happening in the markets and trying to transact for whoever you're either working for. Or if you're an outsourced trader, whoever your end client is. But this is a really important part of the business. And when you have that relationship or you're working on behalf of your client, there's complete transparency.
Meghan: So you're able to help build your own relationships and reputation with the investment banks, which I think is really important particularly in the new issue process. In that regard, we've been mainly talking about secondary trading but the primary market, as you know, is a very big part of the fixed income markets. And in this regard, we are able to really advocate with syndicate desks when getting allocations. And I think that this is really important. In this aspect of the business it's very important to have that transparency, and also those relationships because then you can really get as many bonds as possible for your end client.
Stewart: Yeah. And I think it's fair to say, for those people who may not know that allocation process. I mean, if you're not known to that bank you are highly unlikely to be getting allocations, right. It's just, you're not just going to show up and cherry pick some new issue bond. And to your point about being on the phone all day, I mean, the fixed income markets trade the same way they have for decades. Right.
Stewart: I mean, the electronification, as you called it, largely just hasn't worked. There's so many different CUSIPs and so many different aspects of trading those bonds, it is real. So how has outsource trading evolved during the COVID-19 pandemic? I think that's always on everybody's mind. And I think it's interesting what has happened here.
Meghan: So outsource trading has evolved greatly during the pandemic. I think the pandemic impacted everyone in a different way, and particularly those of us working at asset managers. I was at an asset manager at the time, or an insurance company where it was an environment where you never thought anyone could work from home. There was no work from home option. If you were out of the office, you were out of the office. But to be forced into an environment where portfolio managers, analysts and traders could all work from their own home and still work effectively and efficiently in a very volatile market was groundbreaking for the entire industry, I think.
Meghan: And now we've proven, we've been in this environment for well over a year where a lot of people are still working from home. And it just gave people comfort knowing we can have the same dialogue, we can have the same relationship with those that we're working with and not have to sit next to them. I actually found that it was at times easier to get in touch with people when we were all working from home because you knew where to find them. As opposed to working in an environment where people are on different floors and you're searching for people.
Meghan: So this gave the industry comfort, knowing that you didn't have to be right next to somebody. And if you take that one step further, maybe that person doesn't actually have to work at your firm. They're still your trader. They're still embedded in your process. You're still talking to them all day long about the markets and about opportunities and about trades to execute and how to time them and what bonds that you should be looking at, but they don't necessarily work at your firm anymore. If you take that one step further, a lot of firms are now considering this as part of their business continuity plan.
Meghan: If you have a trading desk that is not located in the same geographic area where you are, that just brings diversification to your entire business. So for example, when there are power outages in Texas, if your trading desk was Meraki and located in Park City, Utah, you would have been fine in terms of execution. But when everything is located in the same area, let alone the same building, you're taking a lot of business risk. So I think the COVID-19 pandemic has really opened up the industry. And I would say of a more or less slow to adapt industry.
Meghan: As you know, we've kind of alluded to when we talked about electronic trading and fixed income to this idea of outsourced trading and how you can benefit on many ways. And I think cost is really only the beginning. But you think about costs, you think about relationships, you think about someone advocating on your behalf in an industry that is undergoing massive consolidation and where the focus is really on larger scale asset managers. Then on top of that we're talking about business continuity in a time that we need to now think about and plan for the unknown, whether that is we don't know what the event is or what the timing is. And I think COVID-19 was the perfect example of this.
Stewart: Yeah, I think it's a great point. I think that work from home would never have happened had it not been forced. Right. But I think to your point, it worked a lot better than a lot of people thought it was going to. So if I'm going to go out and I'm looking for an outsource trading partner, what are a couple of the key things I should be looking for?
Meghan: I think that there are a lot of things that insurance companies and asset managers should consider when evaluating different outsource trading firms and I encourage all of them to do a thorough due diligence. But I think some of the important factors to consider are, what is the structure of the firm? Is it a standalone company or is it embedded in a broader organization? And what is the relationship between desks? If there is an institutional desk, what is the relationship between the outsource desk and the institutional desk?
Meghan: And think about if any conflicts may or may not arise because of that. And what is the ownership structure of the organization? Is it regulated? That's also important. And are you getting the same focus that you would from your own in-house desk? So what is the end client to trader ratio? There are some firms like ours that have a small end client to trader ratio, so we can really be involved in the process and embedded with managers. There are some that are pure execution, and that may be what you're looking for.
Meghan: Just someone who's just going to solely execute your trades and you have a much higher client to trader ratio in that regard. And I think another important aspect is to think about what is the exact order flow? How are orders being communicated? And what can traders do, or what are traders doing at these outsource companies to help mitigate any kind of trade error? Is there a check-in place to make sure orders are coming through correctly? Is there someone who's doing that sanity check that an in-house trader would also be doing, how embedded are they in the process?
Stewart: And I think it just goes without saying, but I just want to mention it: you are acting as a fiduciary on behalf of your client. Is that correct?
Stewart: Yeah. So where do you see the greatest demand for outsource trading in fixed income right now?
Meghan: I think the greatest demand right now is from small to midsize insurance companies and asset managers who are facing fee compression, cost pressures, and are looking for ways to increase efficiencies and gain access to markets where they are very likely seeing less and less access over time. It may not be apparent, one day to the next, but if you look back on the last three years and five years I definitely do think that their access is decreasing just because of the shifts and focus of where resources are being pulled.
Meghan: So I think that's really where the greatest demand is. And I think that it's going to be valuable for many reasons. Costs are very easy to quantify, so that's a starting point. But I think it's very difficult to put a number on relationships and fixed income is still a very relationship-driven business. Most trades are done by picking up the phone and having a conversation with those that you knowand trust. There's not as much transparency, as you know, at the equity markets, even though we are trying very hard and fixed income to increase transparency and have a very clear picture of where a bond should trade.
Meghan: But we'd touched upon this a little bit earlier, bonds are very different than equities. And I like to think about each bond as its own equity ticker. And you think about some of these companies with hundreds and hundreds of bonds that's as if they have hundreds and hundreds of equity tickers, and each of these tickers has its own story. And it really takes an expert to know how to transact in those bonds. So I think that that's really where the greatest opportunity is. I think it's really a matter of educating that investor base on what the offering is and really understanding how you can benefit from outsourcing your trading.
Stewart: That's great. I've learned a lot. It seems like we just started this and we're getting toward the end of it. I think it's a great topic. I really appreciate you coming on and informing us about, not only outsource trading, but trading in general. We always close with the same question, and I'm going to close it with you. Suddenly take you back to a day in your life that I know that you remember, which is the graduation from your undergraduate institution.
Stewart: Now, regardless of what festivities may have taken place the night before, you are bright eyed and bushy tailed in your cap and gown raring to go there at graduation. Your last name starts with “S” so you’ve got to wait awhile, but finally they get you up there and you walk up the stage and you wait and they read your name and the crowd goes bananas. And you go across the stage, do a quick photo op. They give you your diploma and you smile and wave to the crowd and down the stairs you go. At the bottom of the stairs you meet Meghan today. What do you tell your 21 year old self?
Meghan: That's a good question. I think, if I could go back and talk to my 21 year old self on my college graduation day, I would tell her never to give up. It doesn't matter what people around you may say or do or think. Or whether you look around and see people who look like you, who act like you, who have the same background and history as you. If you want to do something, make it happen.
Stewart: That's good stuff. I really, I really appreciate you being on. Meghan Siripurapu from Meraki Global Advisors. Meghan, thanks for being on.
Meghan: Thank you very much, Stewart. I really enjoyed speaking with you today.
Stewart: Yeah, we're thrilled to have you. It's a great topic, thrilled to have you on. And from our audience perspective, we are always interested in hearing your ideas for podcasts. You can email us at firstname.lastname@example.org. Please like us and follow us on all the major platforms. Thanks for listening. My name is Stewart Foley, and this is the Insurance AUM Journal podcast.