TheBooks

In the previous article, I discussed  how technology can help CTAs with back office tasks and potential headaches. Here I am looking outside the trade, to setting up and collecting and distributing performance information, especially to clients.

Tear Sheet Creation

One of the more time-consuming tasks for an advisor is the production of the marketing summary that is emailed each month outlining the performance of their programs. The production of performance statistics, comparison benchmarks, and other information contained in the document often requires hours of preparation.

Software designed to address this problem allows the author to set up the document layout and style to fit the organization’s requirements, select from multiple charts and tables and save the definition for use each month. When it is time to prepare an updated version of the tear sheet with the information from the most recent reporting period, it is simply a matter of clicking a button and entering the commentary; hours become minutes.

Performance Attribution

As investors and regulators get more sophisticated, the requests for the attribution of an advisor’s returns get more complex. Attribution by direction (long/short), by sector, by market, by strategy, net of commissions, without commissions, by NAV, by trading level, by timeframe, all are becoming standard types of requests. Add to this that these reports are required every day and must be sent to a variety of investors, and not having a flexible reporting database fed directly by your trading and accounting can overwhelm a firm’s resources.

Email Encryption

With the latest Interpretive Notice from the NFA on Rules 2-9, 2-36, and 2-49, the requirement of encrypting all data in motion is nearing reality. This means that any emailed or FTPed report your firm generates and sends will have to be encrypted.  It also means that any client information your firm receives (statements for example) will be encrypted as well.

Manually decrypting files when they are received or encrypting them before they are sent will place an extreme burden on your operations staff because each source and destination will have different encryption keys, passwords, and methods.

Solutions like subscribing to a service that encrypts all emails is one approach. A more flexible, easy and cost effective approach is a system that is integrated with your trading and reporting systems and automatically encrypts files and reports that are to be sent as part of the sending process and decrypts statements or other inbound client information as it is received.

Performance Fee Calculations

Handling managed accounts often means different fee calculations for each account. Daily liquidity means additions and withdrawals can occur at any time. Combine the two and you now have a complex performance reporting and fee calculation environment. Yes, it could be done in Excel, but no, that is not traceable and it is prone to errors from simple copy/paste mistakes.

A better solution is a system that is directly linked to your trading and calculates performance using the daily compounded returns method, allows formula-based fee basis formulas for management and incentive fee calculations at the account level, and automatically adjusts the high water mark when additions or withdrawals occur. The results are daily NAVs without the need for manual intervention or the risk of error that a spreadsheet brings.

Client Reporting

What do you do when each of your clients want different types of reports each day? If you don’t have a flexible system designed specifically for customized client reporting, someone in the firm spends time after the close preparing the reports and manually sending them to clients.  If, for some reason, that person has the day off, the process may not run as smoothly under the best circumstances. If something in the “process” goes wrong, life gets very interesting.

If, instead, you had a system that allowed you to define what types of reports each client is to receive, in what format, via what sending method, the reports would get produced automatically as part of the end of day process; no manual intervention required.

In these two articles, I have outlined the key areas where effective automation is key to the smooth and cost-effective operation of a CTA. Systems that have been designed to be flexible and integrate all the aspects of a CTA’s operation provide a higher level of client services at a lower operational risk and are able to grow with the organization.

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Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com

Operating a CTA is not always the glamorous, flashy career that the uninitiated believe it to be.  It involves many tasks that can be tedious and error prone but must be performed flawlessly every day. Add to that, the ever-increasing regulatory burden, and you have something that can wear down the stoutest of traders.

While many, if not all of the tasks related to the operation of a CTA can be made easier and more reliable through the use of technology, there is a big difference between solutions that address procedural issues in a very specific way and ones that are flexible by design and can be configured to accommodate changes as they occur.

In the next two articles, I will discuss the primary problem areas common to every CTA and how they can be addressed in a flexible and reliable manner. In this article, I will look at back office trade issues.

Account Reconciliation

The reconciliation (trades, cash balances, and positions) of a firm’s accounts with its clearing brokers is a daily job that can be one of the most time consuming processes in a CTA’s operation. Yet it doesn’t have to be with the right technology.

The ideal system is able to automatically accept emailed statements (data files or human readable statements) and/or reach out to FTP sites to download them, unzip and/or decrypt them, extract the data while performing translations so the varied statement formats are transformed to the CTA’s standard, and finally, prepare break sheets for trades, balances, positions, and trading commissions. The system should be configurable by the user and be able to accommodate new and changed statement formats without the need for coding changes.

A system with capabilities such as these reduces the time and effort involved with reconciliation to almost none.

End of Day Trade File Production

Any CTA knows that there is no standard format that administrators and broker back offices want for the trade files that must be sent each day. Not only is the layout up for grabs, but the content, symbology and price format can vary as can the transmission method (email, FTP, sFTP …), not to mention file encryption requirements imposed by some (soon to be all) organizations. Manually producing and sending these files is a burden for any but the smallest advisor and developing (and maintaining) software for each new format is not in an advisor’s core competencies.

The best automated system integrate trading and account management as well as incorporating multiple communication modules that allow end-user specification of file layouts per destination, symbology, and price format. It automates the entire trade file production and transfer process and allow those files to automatically be sent without the need for user intervention.

Trade Capture

Trade capture can mean many things. It can mean a direct to the exchange or trading platform FIX connection, it can mean importing trades from a data file, or it can mean the data entry of fills received from a broker via email. In many CTA environments, it is a combination of two or more methods.

It’s important the system used by the CTA is able to capture the trades, convert the symbology and pricing to the CTA’s standards, and process them continuously and reliably, during all trading hours. Equally important is the ability of the system to be configured to adapt to accept additional or changed trade sources with a minimum of time an effort.

A robust and reliable automated trade capture system is the core of an institutional CTA and saves countless hours of effort and minimizes the errors associated with manual or piecemeal approaches.

Trade Allocation

Trade allocation is a term that conjures up one of two meanings: how a number of contracts is to be divided among several accounts when sizing a trade, or, how received quantity/fill price pairs are divided among the accounts that make up a trade. In either case, failure to do it fairly and consistently will land you in a heap of trouble with regulators (and maybe clients).

In the case of sizing trades, the typical method of contracts per million of trading size is pretty straight forward unless accounts within the trade are valued in different currencies, then a currency conversion to the model account currency must occur. For traders that ladder in and out of positions, a useful approach is to base the trade size on a target level of contracts per million after the trade is fully filled. This eliminates the rounding that occurs if each entry is sized in isolation.

For price allocation, many organizations have moved to APS. Unfortunately, not all markets can be APSed and not all clearing brokers APS the same way. Your software should be able to APS the trade in such a way that the approach used by each clearing broker involved in the trade is followed.

Better still, if your trade sizes can support it, use a simulated APS that apportions the actual fill prices in such a way that each account gets a mixed fill that is as close to the trade’s average price as possible.

I have covered the key areas of automation that must exist in the CTA if the firm is to be able to attract funds and maintain a low risk operation. Not only should these areas be automated, but they should be automated in a way that is flexible to ensure the processes can evolve as the needs of the CTA change. In my next article, I will focus on collecting and distributing performance information

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Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com

Earlier this year, the NFA implemented rules that CTAs, CPOs and others must have in place a cyber security and compliance plan that provide a detailed outline on the firm’s daily behavior in following the rules, as well as a step-by-step disaster recovery plan.

Although the regulator isn’t calling in these plans, it will check them during an audit, and if you aren’t prepared, you’ll be in violation. Compliance has been upped largely due to Dodd-Frank rules, but also because the NFA and exchanges are under increased scrutiny by the CFTC.

That said, there are key areas of compliance across all regulators that need to be part of the game plan for a firm’s daily operations. Here are important aspects to include in your plan:

1. Know your vendor and customer:  NFA Bylaw 1101 “prohibits NFA Members from doing business with most non-members that are required to be registered with the CFTC as an FCM, IB, CPO, or CTA.”  Basically, you must do business with your own. It’s up to the CTA to make sure clients, business associates, and brokers are all registered or exempted. The NFA requires you to be able to show not only the process your personnel takes to check out the potential vendor, and that means checking them through BASIC, you need to keep all the documentation on had to show your research.
   
   You can roll the dice and assume vendors are members, but that’s not good business. For example, let’s say you know three friends, traders, who pooled their money to invest in your CTA. First, you must make sure the key person is a qualified investor, but you also must make sure if they are a pool, all investors are qualified, and you must retain documentation confirming the fact.  In other words, if they are representing themselves as a pool or FCM, they must be registered with the NFA.  For more details on 1101, go to: https://www.nfa.futures.org/NFA-faqs/compliance-faqs/bylaw-1101/index.HTML
   
   
2. Make sure from a CTA standpoint, your automated systems allocating trade orders are “equitable and fair.” This should be checked quarterly.
   
   
3. Related to #2, make sure that all accounts within a program have substantially the same performance and that performance is what your marketing materials state for the program.  If different accounts have substantially different performance, the regulators may take the stand that you actually have more than one program.
   
   
4. Not only must a CTA know who he’s dealing with on multiple levels, he needs to know what his vendors are doing, especially FCMs. One compliance expert says a CTA needs to be on top of not only filled orders, but the source data as well.  FCMs don’t necessarily hold the old back up files of trade audits (and if they do, some charge for it), and if an exchange comes asking for it, a CTA must be able to put his hands on records and source data that can build an audit trail or trading activity, and be able to produce it in a short amount of time.
   
   
5. Sometimes slip-ups can happen due to changing regulations but often they happen due to bad communications between an FCM and client. For example, those who trade metals might be using exchange for physicals (EFPs), which are executed thru the FCM to get a futures equivalent position. In some cases, block trade rules come into play, meaning there are minimum lot sizes to a trade. The CTA must understand the rules when dealing with an executing brokers so he doesn’t unintentionally break any. 
   
   As an example,  if a CTA is doing a gold trade, but the executing broker could only get a partial fill, thus it’s not a block trade but an EFP, but the CTA doesn’t know this and if the FCM doesn’t do the paper work – and sometimes they don’t – the CTA is in trouble. Be on top of those trades; in the past, it used to just be a venal sin: one of not knowing. Today it’s a mortal sin, says one expert, stating that CTAs must follow up on trades.
   
   
6. Allocation of expenses between the manager and funds, and between funds has been the focus many recent examinations and common issues have included charging expenses that are not fully disclosed to investors and charging one client an expense where another does not pay the same expense.  Examiners have been aggressively drilling down on expense allocations even when the amounts are minimal.

While NFA audits have not been as frequent during the past few years due to the recent influx of new members, the NFA has recently reached what they consider appropriate staffing levels and you should expect audit frequencies to return to normal.  It’s time to make sure you are dressed appropriately for the party.

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Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com