Trade Compliance from a Portfolio Manager’s Perspective

An interesting dynamic exists between the Compliance team and Portfolio Managers at many investment management firms. Portfolio Managers complain that the Compliance team is slowing them down, whereas Compliance professionals fret when Portfolio Managers demand that Compliance ‘fix it’. With few exceptions, there is tension between Portfolio Managers and Compliance. 

But why exactly does this tension exist? Of course there is a balancing act between efficiency and compliance, but there is more to it. To understand better, let’s first go over how orders are created, and importantly what the Portfolio Manager’s perspective is.

In most cases decision-making is done via a combination of external analytics tools and homegrown spreadsheets. The process typically starts with the Portfolio Managers having made a decision. This could be as simple as adjusting the concentration of a single name in a single account, to as complex as adjusting sector weights across multiple portfolios that result in hundreds of individual trades. The last step of this process is to input orders into an Order Management System (OMS). The Portfolio Manager wants to ensure the agreed upon intent is accurately followed and views the OMS as the system that allows this to happen efficiently. 

Portfolio Managers actually want to ensure that the compliance function is run on every order, but they only want to see legitimate compliance issues brought to their attention. Herein lies the problem: only showing legitimate compliance alerts is harder to achieve than it sounds even when rules were initially written correctly. Why? Because sometimes:

  • Compliance rules are not fine-tuned in a timely manner and trigger an alert or warning in error. For example, if the mandate on sector concentration changes and is not reflected in a compliance rule, it will trigger incorrectly.
  • Compliance rules are too sensitive. Sometimes, a compliance rule will provide warnings when a limit is about to be breached. But often the settings of the compliance rules are such that many warnings are generated without a breach occurring. The compliance rules need to be ‘tightened’ in this case on a proactive basis.

Portfolio Managers do not like to be encumbered in the process of getting an order to the trading desk. They are looking for simplicity. If something is not relevant, it should not be shown. They want the order to be executed quickly after an investment decision has been made. This also helps track performance accurately. In this type of situation, Compliance can become the villain if not properly set up.

Portfolio Managers like legitimate compliance alerts with simple language clearly explaining why the order cannot proceed. A paragraph does not help. Neither does a cryptic 3 word statement. A succinct statement saying the order is over a limit followed by pertinent details, for example, is best. Typical OMS systems allow the Portfolio Manager to drill down into the message and see more details if they need to.

This begs the question: what is a legitimate compliance alert? The obvious answer would be anything that violates a mandate. But what about warning the Portfolio Manager if they are close to the boundary? Or how about if an internal mandate is tighter than the client mandate to protect the firm? Compliance alerts and warnings can become overwhelming if not controlled; if there are too many alerts coming up, the Portfolio Manager loses interest in pursuing and just calls the Compliance team to ‘fix it’. 

At IMP, we believe that alerts and warnings with clear language that come up only when they truly indicate a breach or an imminent breach are ‘good’ ones. Everything else is noise. The Compliance team needs to tweak the compliance library as needed to ensure it remains relevant, updated and is not noisy. This means that there needs to be periodic conversations between the Portfolio Managers and Compliance to understand the Portfolio Managers viewpoint on the current state of pre-trade compliance and to educate them as needed. Our experience working with multiple clients shows that a little proactivity from the Compliance side calms things down, and allows an environment of trust to develop between the Portfolio Management and Compliance teams.