AIMA

The Alternative Investment Management Association

Alternative Investment Management Association Representing the global hedge fund industry

The proof is in the workflow

Clare Flynn

Beauchamp Financial Technology Ltd (a Linedata Services company)

Q2 2006

 

Technology tools have much to offer to the alternative investment world, whether in mitigating operational risk or creating competitive advantage in trading. Fund management companies are spoilt for choice when it comes to software that helps them maximise efficiency, but choosing functionality is the easy part. More difficult, and often not considered until it is too late, is the task of choosing tools that already interface with each other and integrating them into a fully efficient work flow plan.

Take electronic trading, for example. Order management and execution management tools have been available for several years now, and increasingly traders and fund managers are appreciating their value-added in terms of speed of execution and cost reduction. But if an order management system or execution management tool does not interface with the portfolio management system in real time, much of the advantage that may be derived from smarter trading will be wasted on hiring operational staff to re-key trades into another system and maintain the security master in multiple places.

Even systems where the interface is an end-of-day trade file exported from the execution management tool or order management system into the portfolio database are missing a trick: how can a manager reliably trade off position data that cannot be instantly amended for back-dated trades, cancels/corrects, corporate actions and suchlike? There is nothing more disturbing to a fund manager than knowing that his/her view of the portfolio is not reliable.

Access to reliable data

One answer is to buy a fully integrated trade and portfolio management solution that is capable of reflecting any change to any transaction directly in the profit & loss and position reports, in real-time. Certain portfolio management systems providers offer an order management system that is linked directly to the portfolio. The user can employ functionality such as portfolio rebalancing and pre-trade compliance, create and route orders electronically, and watch executions and allocations hit portfolios immediately. Meanwhile, as middle and back-office personnel amend trades from previous days and weeks, these amendments also flow through to the portfolio straightaway, rather than at the typical end-of-day batch process. In other words, the manager has access to reliable data all the time.

Of course, no one system can be all things to all people. What if the firm requires trading tools that are not the standard within the integrated solution? What if the manager has found a specialist piece of trading technology that he/she simply cannot do without, or what if the fund management company has developed a proprietary trading tool?
The answer, in most cases, is FIX drop-copy. FIX drop-copy is effectively the ‘cc’ function on email, but applied to electronic trading messages. It means that a trader can use any number of specialist execution and/or order management tools (assuming they communicate via the market standard FIX protocol) to create and route trades, and when the executions come back, they are ‘cc’d’ to the portfolio management system and automatically booked to the database. So FIX drop-copy means that executions can be reflected in the portfolio in real time, and without the need for re-entry of data. Good portfolio management system vendors should be able to supply customers with a list of off-the-shelf FIX drop-copy interfaces.

Minimising human error

Integrated OMS and FIX drop-copy are examples of how a fund management company can interface with its trading counterparties for superior revenue generation, as well as cost savings reaped by minimising the need for human interaction. The same holds true for the middle office and the world of trade confirmations. The traditional workflow for trade confirmations is as follows:
 

 

Proof is in the workflow

 

Where a trade-matching system is not in use, once a trade is filled, the executing broker faxes the fund manager a confirmation. One of the fund manager’s operational staff receives these faxes throughout the day and checks them against the trades that have been entered into the portfolio management system. Trades that match get sent on to the prime broker, while those that do not are flagged as ‘trade breaks’, which then must be followed up through communication with the trader and the executing broker. Where the trade has been executed electronically, either through an integrated OMS or via FIX drop-copy, trade breaks are normally easy to solve – the executions that the broker has sent via FIX have automatically been booked to the database (which in itself renders errors highly unlikely), so they can be queried instantly, no matter how many days have passed since the trade occurred.

However, where the order management system or execution management tool is not integrated with the portfolio management system, chasing a simple trade break can become more complicated, as the relevant details of the trade before it was re-keyed or uploaded into the portfolio management system may have been stored in any number of different databases. Likewise with non-electronic trades, because the trader will have entered the executions by hand (rather than receiving them electronically from the broker), there is additional room for human error.

One step further

Fund managers with heavy trading volumes may choose to take workflow integration one step further by using a trade-matching system in the middle office. Again, the key is making sure that the portfolio management system interfaces with the trade-matching system. In this scenario, the trader executes a trade through a broker, either electronically or over the telephone, and receives back a fill (or many fills), which is then booked to the database either automatically or manually. The portfolio management system sends trade files back and forth to the trade-matching system throughout the day, which this system matches against trades it is also receiving from executing brokers throughout the day. Where there is a trade break, the system flags it and notifies the user. This dramatically reduces the time spent by fund management company personnel on trade confirmations.

In the back office, the key to efficient workflow is a portfolio management system with ready-made interfaces to the fund manager’s prime brokers and fund administrators, whereby the system can be set up to post trade and/or position files to the relevant third-party service providers at specific times during the day. An even bigger saver of operational time (and therefore money) is a reconciliation engine that can match the prime broker and/or fund administrator’s records with those held in the portfolio management system and isolate the exceptions for easy follow-up.

The moral of this story is, no matter how clever they are on their own, technology tools that are not integrated to maximise workflow efficiency can be a waste of money if people need to get involved to re-key data or if the fund manager’s view of the portfolio is not reliable. All fund managers, regardless of size or strategy, should pay as much attention to the interfacing capabilities of a software tool as to its core functionality when looking to make a technology investment.

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