While the day-to-day users of the Aurisoft suite include operations staff, portfolio managers, relationship managers etc., we are also focused on providing the organization’s executives with a convenient management oversight framework to monitor operating anomalies and to ensure operations are performed effectively and efficiently. The following sections include a discussion of how our application addresses these issues. You will also see that the individual modules are not isolated, but work in concert to provide an integrated control environment.
The discussion below deals with the pitfalls encountered when investment management organizations use a portfolio accounting system and various discrete supporting applications, but have not implemented an integrated process flow and control system.
When asked about the state of the holdings reconciliation, senior executives tend to dismiss the issue, saying that the operations manager has it well in hand and there is no reason to change anything. Later in the conversation we hear about: clients complaining about errors on their statements; holdings adjustments made without understanding how the errors occurred; excessive overtime and staff turn-over; delays in producing client statements; and re-runs of client statements when systematic errors are discovered.
These complaints are symptomatic of an ineffective reconciliation process. In these situations the basis of the reconciliation might be a hard-copy listing that is distributed daily to the administrators and the prior day’s listing is discarded. The consequences of this approach include:
• No convenient way to identify high value breaks;
• Difficult to distinguish current versus old breaks;
• Serious breaks are masked by spurious or temporary items;
• No audit trail of work performed, management is relying on the diligence of individual administrators but has no effective means of supervision;
• No approval process to set-aside permanent breaks;
• Difficult to assess workloads and backlog;
• Trading may be based on bad data resulting in costly reversals;
• Statements may be generated while there are unresolved breaks.
The Aurisoft reconciliation module was designed to deal with these issues, allowing the administrators to manage their work efficiently and ensuring that senior executives have reliable and concise information upon which to evaluate that work.
Portfolio Performance Analysis
Investment managers evaluate their effectiveness by tracking the average, or composite, rate of return for the portfolios that are assigned to a particular investment mandate, or model. The expectation, of course, is that portfolios following a particular mandate would have similar rates of return. While this statistic is important, it is not the whole story. The variability of returns within a mandate is also a significant indicator of management and administrative style.
In addition, if there happen to be any operational anomalies hiding among the portfolios, they are very likely to reveal themselves by showing up in the high or low side performance outliers. Our performance analysis module identifies these outliers and provides the structure for documenting the investigation and resolution of these anomalies. The status of these items becomes a benchmark in the validation of individual portfolio performance as well as the composite rates of return. In turn, the completion of this work is a key step in the data integrity verification in producing client statements.
The investigation of the outliers would include:
• Checking whether there are persistent holdings reconciliation breaks, by direct screening of outstanding items;
• Comparing actual account holdings with the appropriate model holdings, see below;
• Scanning the transaction history for unusual activity using the client reporting module;
• Verifying the period-to-period account data integrity using the cash flow report;
• Reviewing month-end holdings reports for missing or anomalous security pricing, which are flagged on this report.
On-demand summary status reports are available to senior management to track the progress of monthly or quarterly accounting cycles. In addition, they can drill-down to the specific items that may represent roadblocks to smooth operations.
Portfolio Holdings Analysis – Portfolio Rebalancing
One of the key policy decisions in managing a book of investment portfolios is the determination of how frequently to rebalance. In some cases, the portfolio manager may make major changes to the weightings of specific holdings in the model, or completely eliminate securities or add new securities. In this case, it would be a straight forward decision to perform an across the board rebalancing. However, on a day to day basis, minor changes to the model or cash flow activity in individual accounts create creeping model drift. In the absence of a robust portfolio screening tool, this model drift can result in an unacceptable growth in the variability of rates of return for an investment mandate. In addition, it is not very satisfying to have to explain a performance outlier by admitting to having forgotten to rebalance the account for the last six months.
The decision to rebalance an account is a trade-off between tracking the mandate model and incurring trading costs that impact the client, as well as the management organization. Our portfolio rebalancing module allows for the analysis of how closely individual accounts track the model by applying user-defined criteria to compute an aggregate “off-sidedness” statistic. This process screens the accounts within a particular mandate to identify those accounts that are most deserving of rebalancing and produces a suggested trade list. Management can tune the criteria used so as to achieve an optimal trade-off between model tracking and trading expense.
At a lower level of detail, the suggested trading list can flag specific anomalies that should be resolved before the rebalance is executed. This includes missing/stale prices and outstanding reconciliation breaks for particular holdings. The trade list may be edited to adjust or eliminate specific trades as a means of avoiding problems with items thus flagged.
Client Statement Production
Client statement production represents the culmination of an investment operations cycle. On a day to day basis a variety of events occur that result in the account records being not quite up to date: failed trade settlements, pending cash transfers, partially or incorrectly processed corporate actions, etc. When statements are generated, we are “writing in ink”. That is, all of these anomalies must be resolved at the reporting “as of” date prior to the release of the statements. In the above sections, we reviewed some of the control tools that we use to identify and to track the resolution of anomalies or potential error conditions. At reporting time, all of these tools must work together to ensure that the statements accurately represent the investment accounts and that the statements are produced on a timely basis.
As is the case with any non-trivial process, statement production entails trade-offs. By tracking the status of individual anomalies we can selectively extract accounts at certain points in time. This allows for the generation of statements in tranches so that the bulk of the statements can be released early in the cycle while the troublesome statements can be held back pending the resolution. In the absence of the integration that Aurisoft provides, managers set an arbitrary date by which the data validation is to be completed. At that time all of the statements are released… right or wrong.