Investment Strategy

Investment Strategy (otherwise known as Asset Allocation Policy) is typically established by a central group of Investment Professionals under the management of the Chief Investment Officer. The objective of Investment Strategy is to determine the House position on market prospects and to provide targets for the allocation of Funds by the Fund Managers.

Active Fund Managers claim to deliver investment performance that consistently beats clients’ agreed benchmarks through applying a disciplined investment process that encompasses stock selection, asset allocation and currency hedging (for an internationally diversified portfolio) within the risk parameters set by the client.

Passive Fund Management is also used by a number of houses. Portfolios usually track an index and move into and out of stocks as the index moves. This results in the portfolio mirroring the performance of the index.

Research

Research is central to every part of the Investment Process. At the macro or strategy level, research is a contributor to the asset allocation process. At the micro or stock level the quality of research is the major determinant of the Active Fund Managers’ performance.

Portfolio Modelling

Modelling refers to the process of generating buys and sales of stocks in response to changes in asset allocation targets, withdrawals and contribution of funds. Increasingly this work is conducted with the assistance of computer-based tools. These range from spreadsheets to sophisticated portfolio modelling and re-balancing tools provided as part of the Fund Manager's front office systems.

Modelling can be conducted at a total fund level in response to a change in global asset allocation targets; at a regional level in response to country target changes within a region; and at a country level in response to sector target changes within country.

Typically the modelling system will suggest trades to the Fund Manager that will allow him/her to re-balance the portfolio in line with the target changes which will then be edited until the Fund Manager is satisfied with the result. At this point the deal requests will be passed to the dealing function to action.

Pre-Order Compliance

Otherwise referred to as Guidelines (Client and House) or Mandate (Client) checking.

Client Guidelines refers to the investment controls or restrictions imposed upon the Fund Manager within the Management Agreement between the Client and the Fund Manager. The guidelines will cover restrictions such as:

* Country/region investment exposure – maximum absolute/relative exposure to country/region
* Stock/issuer exposure - maximum absolute/relative exposure to stock/issuer
* Restrictions upon investments in parent company stock
* Instrument type guidelines - e.g. no unquoted securities, no derivatives.
* Number of stock in the Portfolio Guidelines

House guidelines will include restrictions upon House percentage holdings by stock, issuer, country, region, etc

In practice the compliance function needs to be executed at several stages throughout the investment cycle, namely, pre-order compliance, pre-trade compliance, post-execution compliance and end of day compliance checking.

The first point for compliance checking is pre-order. Prior to requesting the in-house dealers to action a trading programme a model of the proposed trading activity should be run across the portfolio to ensure that none of the guidelines will be breached. This is usually achieved by developing a compliance module as part of the Front Office system.

Deal Generation

On completion of the modelling and pre-trade compliance processes, deal orders are created for action by the dealing function.

Prior to the deal order being placed, an Order Strategy process defines the nature of the deal. This will determine if the order will be placed as a programme trade, if brokers should be used or whether the deal should be executed directly with an exchange. The exact strategy taken depends on a number of factors including the type of instrument being traded.

Increasingly orders are created automatically by the Front Office system as a result of the modelling process. Where possible these will be in the form of block trades. i.e. Instead of executing several smaller trades for the same stock for different portfolios a ‘block’ trade will be constructed for the total number of securities to be bought/sold with allocation identified for the individual clients.

Pre-Deal Compliance

Otherwise referred to as Guidelines (Client and House) or Mandate (Client) checking.

Client Guidelines refers to the investment controls or restrictions imposed upon the Fund Manager within the Management Agreement between the Client and the Fund Manager. The guidelines will cover restrictions such as:

• Country/region investment exposure – maximum absolute/relative exposure to country/region
• Stock/issuer exposure - maximum absolute/relative exposure to stock/issuer
• Restrictions upon investments in parent company stock
• Instrument type guidelines - e.g. no unquoted securities, no derivatives
• Number of stock in the Portfolio Guidelines

House guidelines will include restrictions upon House percentage holdings by stock, issuer, country, region, etc

In practice the compliance function needs to be executed at several stages throughout the investment cycle, namely, pre-trade compliance, post-execution compliance and end of day compliance checking.

Prior to the trades being executed with the broker a further compliance check is completed within the Order Management system to ensure that no dealing guidelines will be breached by the proposed deals. Any orders that will breach the guidelines are sent back to the Fund Manager for review.

The compliance rules will be set to include:

• Deal Limits
• Stock/Issuer exposure
• Broker exposure guidelines

Dealing

Orders to trade are communicated from the Front Office system to the Order Management system via Order Generation. The orders may relate to Securities (Equities and Bonds), Foreign Exchange, Money Market or Derivatives trades.

When the Dealing Desk receives an order a working deal is constructed. As far as possible a Dealer will combine all orders for the same stock into one working deal which is then placed with a Broker, or series of Brokers, on the market. The Dealer will attempt to obtain the best price for the working deal whilst not prejudicing the House exposure to an individual Broker. Deal orders historically are placed with the market manually however increasing use is now being made of the FIX protocol – depending on the trade and instrument being traded.

Once the amount of stock and the price have been agreed, the trade details are entered into the Order Management System and the order status of the trade changes to an executed deal.

Confirmation and Matching

The details of the trade held in the Order Management system need to be confirmed with the broker to ensure that all of the details are accurate. Depending on the type of instrument traded, settlement details are extracted from the Order Management system and imported to a matching engineor trade confirmation system. For trades not confirmed automatically, the process must be handled manually with the broker.

Included within the process Confirmation and Matching is Trade Allocation.

Depending on the order that was placed with the market, the trade may be an individual trade that will be processed directly to the relevant account or a ‘block’ trade. A block trade needs to be split into separate transactions internally for the purposes of portfolio management. For instance, several funds may have mandates requiring the purchase of the same stock. A trade for the total stock purchase will be placed with the market but internally the trade will be split between the relevant funds.

Trade Instruction

In order for the trade to be settled in the market place it is necessary to communicate the trade to the Global Custodian. As well as the basic trade details such as settlement amount and details of the stock, it is necessary to add details of the broker’s settlement instructions so that the Global Custodian is aware of the counterparty in the local market place with whom to settle the trade.

Details are extracted from the investment accounting package usually through a piece of middleware that extracts the trades on a real-time or batch basis. The middleware will usually hold a series of tables including broker settlement instructions and custodian account details. The middleware is able to format the message into the required structure.

Trade instructions can be transmitted to the Custodian in a variety of ways. One of the most common methods is to send the trade over the SWIFT network, preferably in the ISITC agreed format.

Settlement

Settlement is the final transfer of cash from the purchaser to the seller in exchange for the delivery of securities.

In theory all securities transactions should settle on time but in reality this varies from market to market as does the settlement cycle.

Settlement details are imported into the Portfolio Accounting system and may also be imported into a separate reconciliations package. The data may initially be routed to a middleware package for formatting and routing.

Settlement Reconciliation

Settlement Reconciliation is the process of matching individual trade records with the Custodian prior to or on settlement date. This reconciliation will be performed on a daily basis to ensure that all of the transactions have been accounted for correctly and that failed trades are identified promptly.

Any items that have not matched correctly need to be investigated with the Custodian to determine the reason for the failure to settle on time. Custodians will provide details of both settlements and fails through their proprietary systems or via the SWIFT network.

These details will be imported, increasingly via middleware, and matched against the records in the portfolio accounting system.