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Trade Allocation Checklist

A comprehensive and robust trade allocation policy can go a long way towards mitigating risk. Our team breaks down the top three trade allocation best practices in this guide.
Portfolio BI
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Top Three Trade Allocation Best Practices

The allocation of trade and other transactions has and continues to be one of the most significant risk areas for registered investment advisors. A comprehensive and robust trade allocation policy can go a long way towards mitigating this risk, ensuring allocations are made fairly and equitably. The complete and accurate disclosure of these allocation policies and practices and the maintenance of adequate books and records are necessary, particularly as the SEC's Enforcement Division has stepped up and continues its efforts to combat cherry-picking intentional or not. Due to the potential risks associated with trade allocations, firms should ensure that they have robust policies and procedures in place. These should consider their portfolio management and trading processes, types of clients and accounts, and other characteristics specific to their firm.  

Systematic allocation process with robust data capture capabilities

Firms should have an order management system (OMS) in place to automatically capture all trade details. This includes a snapshot of the positions, compliance tests (investment restrictions/guidelines), and the trade allocation rules and methodologies that correspond to the trade allocation policies and procedures. In addition, all orders, trades (or fills) should be timestamped to ensure proper oversight and best execution.  

Audit & Control

Investment Managers must maintain books and records related to all orders and trades. This includes the allocation series, a snapshot of the portfolio that includes all compliances tests (pass/fail), allocation rules and methodologies, and potential overrides (including documentation, approvals, etc.). It is also important to have a history to cover trade modifications and cancels/corrects. This will enable the investment manager to recreate past trade allocations, with knowledge date support, during a potential SEC examination or simply a fund allocator request.

Disclosure & Forensic Testing

Firms must ensure allocation practices mirror written policies and procedures and what has been disclosed to clients. Regulators view inconsistencies between disclosure documents and actual trade allocations as a red flag. Firms should review and confirm that private placement memorandums, due diligence questionnaires, marketing materials, and other disclosure documents provided to clients and prospective clients are consistent as well.

Even though most firms are confident that their allocation policies and procedures are adequate; however, they should perform forensic testing to assist with the identification of any patterns or trends that may indicate that individual accounts favor others. Paramount is the systematic comparison of accounts' performance returns within each strategy to determine whether there is any performance distribution. Firms can reduce allocation process overhead by integrating post-trade compliance into allocation and rebalancing workflows.  

Depending on your portfolio management system, you should consider calculating the percentage of trades allocated to each account that was profitable. This test can help identify cherry-picking and other wrongdoing with respect to trade allocations.

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