Portfolio optimization through active compliance
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Ali Curi: [00:00:00] Markets ConversatiON is an ION podcast where we discuss topics of importance to capital market participants with product owners, subject matter experts, and industry leaders.

Steven Strange: The time saving, huge, getting it to the desk quicker. And then, of course, there's trade automation these days. You can get that out to the market and execute it in real time.

Ali Curi: Hi everyone and welcome to Markets ConversatION, I'm Ali Curi. On today's episode, we're talking about something that used to be considered a hurdle in portfolio management, compliance. But not anymore. Active investment compliance is transforming how asset managers work, turning compliance into a strategic input instead of a roadblock.

Steven Strange and Tim Flinders from ION Markets are joining me to discuss how compliance rules are directly affecting portfolio optimization and why managers focused on performance are using compliance technology more than ever.

Let's get started.

Steven [00:01:00] Strange. Welcome back to the podcast.

Steven Strange: Hi, thanks for having me back.

Ali Curi: And another frequent guest of the podcast, Tim Flinders.

Hi Tim. Welcome back.

Tim Flinders: Thanks, Ali. It's great to be back.

Ali Curi: Steven, you're a regular on the podcast, but for our new listeners, can you briefly share with us your background and your role at ION? 

Steven Strange: Absolutely. So I've been working in financial services for over 15 years, currently focused on asset management, which basically covers all the front office technologies from portfolio management, order management, execution, capability and investment compliance. 

Ali Curi: And Tim, please tell us about your background and your role at ION. 

Tim Flinders: Yeah, Ali. I'm based in London. I lead the technology and operations functions globally for our asset management group, in ION Markets. We focus on buy side asset and wealth management.

I've worked with asset managers specifically for about 13-14 years in both front office and back office. 

Ali Curi: Great, thank you. Steven, let's start with you. So set the stage. [00:02:00] How do you define active investment compliance and how is it different from traditional post-trade checks? 

Steven Strange: So when we think about active compliance, we just need to think of the context of what we mean about investment compliance generally. So all portfolios have to have some rules and restrictions that could be regulatory, based on the jurisdiction that you trade in. That could be mandated by the client saying, "I don't want to trade in a certain sector."

For example, tobacco or alcohol or whatever it may be. And then you get into the post of going, "What's the point of going into pre-trade?" Saying, okay, "Well, before I make that decision, can you tell me, should I do that?"

And the concept of active compliance is going, "Well, we already know all of this information. We know what the mandates are, we know what the regulations are, we know how much you are exposed to certain limits, so why don't we bring that further upstream and put that into the optimizer so there's less clicks, there's less thoughts for the portfolio manager, and they can actually see straight away can they invest, can they not?"

Ali Curi: Right. So firms are [00:03:00] now shaping decisions based on what's already compliant. Can you share an example of what that looks like in a real world investment workflow? 

Steven Strange: Yeah, absolutely. So typically when you think of a portfolio optimization system, it's got a lot of inputs. It's looking at fundamental data, it's looking at P&L, it's looking at the forecasts of certain stocks, et cetera.

So you just need to think about it as going, "Well, this is the universe of securities or instruments I can invest in." And then you've gotta go, "Okay, well, I'm managing 10, 50, a hundred portfolios. What can I invest in?" So as you're trying to model and come up with the best investment strategy, you want that instrument universe to be restricted upfront.

So what it's essentially doing is saying, "I already know I can't invest in X, Y, Z stock. So just remove it. Don't even make it an option. I can't invest in the energy sector because I'm over invested in that already, and I'm breaching a limit." So what it essentially does is the time you eventually run a pre-trade check, it has already done [00:04:00] a lot of the upfront work and said, "Well, the optimizer says these are the trades, these are the orders, these are the securities you can invest in," and it really saves a significant amount of time.

Ali Curi: Does this change how portfolio managers interact with optimization tools? 

Steven Strange: I see it as a, it's another input. Optimizers and optimization tools have been around a long, long time. It's another input and typically compliance was considered a barrier. And we'll probably talk about this though later, "Going, ok well, I figured out the best idea that I want to do, this is my decision making idea generation, and now I'm being told I can't do this."

So what we're trying to say here is go, "Well, if you already knew that, why didn't you put that in as another input to automate the process?" So it just gives the portfolio managers the convenience of going, "Okay, the optimizer has told me "X" and now I'll double check it and obviously check my strategy and then I'll submit it to the trading team."

So it just really adds efficiency to their entire process. 

Ali Curi: [00:05:00] Can this compliance change up? Can it actually be a source of alpha? Because that feels like it could be a shift in mindset. How are firms benefiting from that? 

Steven Strange: This is always an interesting question because when you think of compliance, you certainly do not think of a source of alpha.

You go, "Well, actually compliance is a barrier. It's going to prevent you from doing something." But what we like about the concept of active compliance is going, "Well, get ahead of it. Now, you already know you can and can't do this, so let's get to the market quicker. Let's use that to come up with ideas that we can do, and we know the compliance. We don't have to go back and potentially unwind trades and positions and things along those lines." So, it really is just going, "Well, how quickly can I get my idea to the market and use compliance as an enabler for that?" Which is probably something no one was thinking of before, 'cause it's, as I said, it's traditionally always considered a barrier, but considering active compliance, it definitely gives you that ability to [00:06:00] seek alpha.

Ali Curi: I can imagine that there's several measurable benefits; time savings, more effective trade execution. Can you talk about the more measurable benefits? 

Steven Strange: It's really time. Time savings is huge. So the original kind of use case that most asset managers come up against is, "Okay, we know what we're doing. We've got this strategy. We're again, using all this different data sets and fundamentals and stats like that to only find that we can't do something. Which we should have already known about," and it could be, again, mandates, regulatory restrictions are pretty clear, mandate restrictions for your particular clients could be anything.

So if we already know that information, it's just very inefficient to then rework everything you were doing to say, "Actually, this account or this portfolio can't trade this base," on whatever their restriction may be. So time saving, huge, getting it to the desk quicker. And then, of course, there's trade automation these days, so you could get that out to the market and execute it in real [00:07:00] time.

So it's really trying to bridge that gap of saying, "Well, this is what I wanna do now. It's a volatile market. This is the strategy I'm trying to implement. We need to get it done in more or less real time as opposed to having all these blockers, which potentially, just having a standard pre-trade compliance could do."

ION Ad: This episode is brought to you by ION. At ION, our asset management solutions automate your compliance, order management, and trade processing with customizable technology that grows with your business. Gain real-time insights for fast, accurate decisions, all while reducing costs and enhancing security with ION Cloud hosting.

To learn more, visit us at iongroup.com/markets or email us at: markets@iongroup.com.

Ali Curi: Right, and at the backbone of all this, of course, is technology. Let's talk about that for a bit, because APIs and data interoperability are getting a lot of attention. How are APIs enabling more real time integrated compliance decisions?

Steven Strange: It's really just the [00:08:00] idea of being able to get this specific information to the right people at the right time. If you think of either a portfolio optimization system or just any portfolio management system, or just the portfolio manager themself, how do you get that information to them? So as I mentioned, there's a lot of data out there, but how do we get these investment restrictions quickly to them so we can speed up and make it more efficient?

And the only real way of doing that is either providing. Some sort of API or having interoperability with different applications, and that's what's key. So we know there's historic information that you could use to do certain analysis. We know there's compliance restrictions, which we need to extract from one system to another, but rather than have to rewrite everything to the portfolio management system, it's simply just say, "Tell me what my restrictions are. Tell me what my exposure limits are. Tell me what my constraints are." So having this change in technology in recent years is certainly enabling this. 

Ali Curi: How does this help firms [00:09:00] maintain speed in fast moving markets? The usage of technology and APIs, is there still a performance trade off or has that been resolved or is it an ongoing issue?

Steven Strange: There's a couple of things to consider. You have to consider the strategy of your portfolio and is it a fast moving market? You know what's different conditions are based on that strategy. But essentially if you have the technology infrastructure in place and you start to leverage these APIs and have some sort of desktop interoperability that can bring this information together.

That's what you need, because, as we all know, the market moves quickly. That we don't know what's gonna happen tomorrow, and we need to quickly be able to react on certain scenarios. So bringing it all together does require a very updated and efficient technology system. 

Ali Curi: Where would you say people are seeing, firms are seeing the biggest gains? Idea generation, portfolio construction, trade approval, et cetera. Where do you see the biggest gains? 

Steven Strange: So I think this is all upstream from, so more in [00:10:00] the idea generation portfolio construction piece. It's just really trying to find the instrument universe that you, you want to potentially execute those trades within, for your portfolios. And coming up with those decisions fairly quickly. But once you've come up with them, acting on them, and if you combine that, then with trade automation, which then gets into trade approval and hitting the dealer's desks, that's where you start to see a seamless process that goes, "I've had this idea. I've worked out all the fundamentals, I've now checked compliance. Well, compliance has already been checked for me. And then I send it out and we've executed, potentially, in real time." It's really only upstream system, so idea generation portfolio construction. 

Ali Curi: Okay, great context, Steven. Thank you. Tim. Talk to us about the implementation angle, because building this kind of compliance infrastructure, I mean, it seems challenging.

Are most firms starting from scratch? Are they building onto what they already have? What can you tell us?

Tim Flinders: I think from end-to-end active compliance concept. Most [00:11:00] firms are starting from scratch, but we've seen most firms are sharing information between what is in the compliance system, portfolio management tools in a fairly manual way and a basic level.

So it's just duplicating information. To share an example of that, information that helps of value, "Can I invest in something or not invest in something" it might be shared like a list of entities, which might be instruments or industries or generally sort of some level of static information.

And sometimes that might extend to basic limits and credit rating restrictions, but generally this information doesn't need much calculation or aggregation. Generally more binary decisions. 

Ali Curi: And I imagine that there's also the challenge of aligning client mandates with actual rules in the system. What's the key to making sure that nothing gets lost in translation? 

Tim Flinders: So I think this is where the power of active compliance solution really comes into play. You know, exposing information from the compliance solution to the portfolio tools directly. Like I [00:12:00] said in the initial, it might be simple rules and values, but naturally, if you can hook the power of the pre-trade compliance rule evaluation system and the full alignment of the true power that can bring. Potentially you could adjust your decisions, whether it's weights or exposure limits for the portfolio, based on the requirements that you've captured in the compliance system, and then react from that. The complex nature of the compliance rule engines can definitely leverage fully in cooperation with the portfolio tools rather than, as Steve said earlier, as " a gatekeeper," which it's generally how the compliance systems thought about it. It's like, "How do I stop this trade?" But if you can bring that information in earlier, that's where the power of active compliance comes in. 

Ali Curi: And as portfolio optimization becomes more automated, how important is it for compliance to be in the loop in real time?

Tim Flinders: That's an interesting question. You know, we've actually seen asset managers and one particular asset manager in the wealth management space demonstrating [00:13:00] that they could automate portfolio optimization. Based on the feedback of the compliance system. So they would iterate round loops, they would adjust the portfolio to perhaps the max of limits.

It depends what they were doing. And then they would present that results to the portfolio manager and of course at that point it will pass the compliance check unless something changes. So the advantage of that is that you can imagine the frustration a portfolio or fund manager could experience if they beautifully construct a fund portfolio management tool, and then it fails immediately for a pre-trade check or worse in the post trades stage.

And obviously then they need to repeat the exercise, potentially incur costs for more trading if it's found at post-trade. And frankly, it's a waste of time and money. 

Ali Curi: Now that's quite the shift. Is the role of the compliance officer changing as well?

Tim Flinders: Ultimately the main and central role of compliance officers is the same.

After all the compliance officer is there and [00:14:00] place to protect the fund from regulatory requirements they have to keep to, or maybe it's fund or firm specific rules, that's their key role. That said, I think this leads to more dialogue potentially between portfolio optimization roles and the compliance functions, and potentially might even lead to launch of perhaps new funds that can leverage the complex rules and work with that potentially aids the differentiation of a fund.

Ali Curi: And this question is for both of you, but Steven, let's start with you. Is active investment compliance the new standard, or does it still depend on the firm's scale and tech maturity and any other factors? 

Steven Strange: It's certainly becoming the new standard, but it does depend on your size, the maturity in terms of the technology that you have, but really the strategies that you're investing in, the amount of portfolios you have, the decision making that you need to do. So in some cases, automating all this process may be unnecessary.

But for larger firms, it certainly is the direction of [00:15:00] travel. 

Tim Flinders: Yeah, I agree with that. It really depends on where you are, and where you want to get to. We still have funds that are modeled in homegrown portfolio solutions and even in Excel. So, as it evolves, embracing the new ways of approaching things.

Makes sense. So considering that active compliance should be on your list, if it, you haven't looked into it. 

Ali Curi: Again, this question is for both of you, but Tim, we'll continue with you. What's the one big thing you hope listeners would take away from this episode?

Tim Flinders: I think that your organization has information locked up in systems and processes that are disconnected from each other. Eventually, even in different departments.

And by rethinking and redesigning the links, you can unlock new levels of power and efficiency for your fund. 

Ali Curi: Steven, what are your thoughts?

Steven Strange: A hundred percent agree. I think sometimes people overlook the value of compliance information. It sounds that, again, it's restriction, it's compliance. It's not the most exciting of topics, but it's a hugely valuable data set, and using the [00:16:00] technology that we have available now, you can redistribute that throughout an organization and obviously one being to the portfolio managers benefits.

That's certainly something that I think people should consider. 

Ali Curi: Now, Steven, let's continue with you. I've asked you about career advice in previous episodes. My question for you today is, "What is one book that you've read that really made an impact for you, either personally or professionally?"

Steven Strange: There's one book that comes to mind that I've read multiple times. It's called "Misbehaving" by Richard Thaler, and it's a very interesting concept to me, both personally and professionally. And what it looks at is behavioral economics. So we all know about economics and economic theory. But it's bringing in the idea of psychology and how people make decisions and how those two worlds blend together.

So I find it fascinating, as I said, from a personal perspective, but equally in my own day-to-day of, "Why did a user want to do this?" Or, "Do they really want to do this?" "Is that the actual requirements?" I find it a fascinating book and [00:17:00] it sources a lot of other very academic books, but it's a great read to get the kind of high level details.

Great. Thank you for sharing that. And Tim, same question. What is one book that you've read that really made an impact for you, either personally or professionally?

Tim Flinders: Wow. That's a... that's a difficult question. I do like to read a lot of biographies and learn from other people's experiences. That said, I think I'll probably choose a non-biography book that does learn from people's experiences in firms. And this firm's relatively old now, but helped me transform the way I think about running a software enterprise. Book's, "The Lean Startup" by Eric Ries.

Some real insights into how you can do continuous product development, building things right from feedback and don't be fooled by the name. The concepts in here are apply across the whole enterprise world outside of startups, so I really recommend it. It's definitely a relevant read for today.

Ali Curi: Well, thank you for sharing that. And gentlemen, this has been an informative, deep dive into how compliance is evolving from [00:18:00] barrier to performance booster.

Steven Strange. Tim Flinders, always good to see you. Let's do it again soon.

Steven Strange: Thanks Ali.

Tim Flinders: Thanks Ali.

Ali Curi: And that's our episode for today. You can follow ION Markets on X and on LinkedIn.

Thank you for joining us.