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Accounting from broker statements; not such a great idea


Permalink 09:51:31 am, by Dana Comolli Email , 646 words   English (US)
Categories: Reconciliation, Accounting

Accounting from broker statements; not such a great idea

This sounds like a great idea: generate accounting and performance numbers for managed accounts and funds by reading broker statements.

On the surface, it is a great idea; unfortunately, it is not likely to succeed in the context of a CTA or hedge fund that trades futures and/or FX; not to mention over the counter instruments such as swaps.

There are several reasons why this can’t work reliably. The most notable are:

  • Traders of any size have out trades every day. Basing accounting on the contents of broker statements that have missed or incorrectly booked trades is guaranteed to be wrong.
  • Broker statements for futures are cash based, not accrual based. They do not include the accrued trading commissions for the exit side of the trades. If performance is based on the contents of the statement, that performance will be over-stated by the amount of the accrued exit commissions. The statements also do not contain accrued interest on cash held at the broker. Again, basing performance on the contents of the statements results in inaccurate performance calculations.
  • Statements do not include management or incentive fee accruals. These must be calculated outside the context of the data on a statement.

Another problem that believing what is on a statement causes is it defeats the whole concept of reconciliation. By accepting what is on a statement, the advisor is in effect, doing the same thing as never balancing a checkbook.

In the case of an investment manager, he is being paid to manage the money of his investors. It is the manager’s responsibility to ensure that trades are booked in the correct account at the correct price, that positions are accurate and balances are in line. Basing accounting on the contents of the statements bypasses these important checks.

A better approach
If you assume an investment manager must maintain the list of trades she has made as well as her open positions in order to effectively run her business, she is already most of the way to being able to produce the required financial performance records.

A system like TheBooks is designed to take advantage of this fact. It provides simplified recording and reporting of trades and automatically keeps track of positions (both net to the street as well as by system/strategy) and it generates the appropriate accounting entries resulting from those trades and open positions.

A clear advantage of this is that reconciliation can be performed at the trade, position, and cash balance levels (another capability of TheBooks). In addition, because commission, fee, and interest accruals are also performed by TheBooks, the resulting accounting and performance reporting numbers are accurate.

Another advantage to performing your own accounting rather than basing it on the contents of broker statements is time. If accounting/reporting is based on broker statements, there is no easy way to provide end of day performance reports. All reporting must wait until the statements are received; typically early the next day.

TheBooks reporting is based on the trades that have been posted and the market prices as they are now. This means that end of day reports detailing daily/monthly/annual performance (summarized or detailed by sector and/or market) can be sent automatically at the end of the trading day; significantly improving the level or reporting and transparency an advisor can provide to her clients.

An advisor must maintain a record of his trading activity. Using a system like TheBooks not only maintains a record of all trades, it maintains positions and generates all the performance and accounting records required in a way that delivers more accurate and timely reports than those that can be produced by using broker statements.

Beyond that, it provides the basis for robust trade, position, and cash balance reconciliation, helping the advisor manage the inevitable trade and position discrepancies that occur when trading futures and FX.

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