Overview of Investment Process

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Now let us look at the entire investment process. Imagine that you have recently signed an IMA with an institutional investor. The first thing you need to do before receiving money is to setup all the accounts.

Account Setup

Although you might already have existing relationship with different brokers, you would need to setup separate trading account with your brokers to trade on behalf of your new client. You also need to establish trade confirmation protocol with the respective brokers. In addition, you need to setup a new account with the custodian bank and establish standard trading instructions. You would receive cash or you might receive cash & stocks from your client on the day of the commencement.

Constructing Investment Portfolio

Before you received the money, you would need to construct the investment portfolio for your client. On the day you received the money, you need to implement the portfolio within a period of time stipulated in the IMA. Please refer to the article “How Fund Managers Manage Investment” and “Investment Philosophies & Strategies” if you would like to know briefly how fund managers manage an investment portfolio. The most common practice for fund managers is to implement the portfolio based on a previously constructed model portfolio.

Portfolio Implementation

Once the portfolio is constructed, the implementation of portfolio is done by the support staff under the supervision of the fund manager in-charge. A portfolio re-balancing exercise is done against the model portfolio. During portfolio re-balancing, the system would distribute the cash to the respective stocks and trading orders are generated. If you received stocks and cash, the system would determine how much more to buy compare against the existing holding and sell those stocks that are not in your model portfolio.

Trading

The trading desk would receive the trading orders from the front office system. For a smaller setup, boutique fund manager uses spreadsheet to calculate the trading amount and he either place the order himself or hand it over to the trader. On rare occasion where there is a buy on a new account and sell on the rest of the account, the trader can create a married deal based on a predetermined price and adhere to the married deal guidelines of the respective exchange.

The trader then distributes the trade quantity to a number of different brokers. This is to ensure that different brokers can execute a better deal; because by splitting the trade among different brokers, the market would not know how big is the order. This practice also prevents front running by brokers. Sometimes, when the trading quantity is high it may take a few days to complete the trade. 

Once the trade is complete, the completed trade will flow to the back office.

Trade Confirmation

Trade confirmation is done by the back office to ensure that the completed trade is accurate when check against the broker. This practice is to reduce trading error and prevent trade dispute and at the same time prevents rogue trader from creating bogus trade. The back office will received trade confirmation from the brokers and it will match the order against the completed trade ticket issued from the trading desk. For a smaller outfit, this process is usually done by hand. Larger investment uses their computer system to do order matching. Some companies use external services such as Omgeo to do order matching.

Settlement Instructions

After the orders are confirmed, the back office staff will need to issue settlement instructions to the respective custodian. Most of the custodian only accepts settlement instructions uploading to their websites. Some custodian banks still accepts fax, however, such practice is discourage in favor of web entries. Larger firms use SWIFT transfer to send settlement instructions.

Foreign Exchange

For global accounts that deals with multiple currencies, the front office system will generate all the necessary foreign exchange (forex) instruction. These forex instructions may flow to the trading desk if there is someone that could deal with the foreign exchange market. Most of the time, such instruction will flow to the back office and the back office will send the forex instruction to the custodian bank since the cash account is maintain by them.

Portfolio Reconciliation

Portfolio reconciliation is usually done on the next day. The purpose of portfolio reconciliation is to compare and confirm the stock holding records of the custodian against the fund manager's system. Any discrepancies between the custodian and fund manager have to be resolved.  

Trade Settlement

The actual trade settlement is done by the custodian. Most of the time these trade settlement is done with computer system without any problem. However, failed trade can occurs if the counter party failed to deliver the stocks or there is insufficient fund. Most custodian banks will cover failed trade since they have a large cash and stocks holding. However, they would charge a fee and report such incidents to the investor (your client). On such occasion, the fund manager has to bare the charges. Such error rarely happens because most of the trade orders are computed by the system. Human error happens when the whole trading process is done manually.

Below is a flowchart of a typical investment process.

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