Equity Fund Management –

Processes and Practices Module V

Compliance and Dealing Room
Learning Outcomes-
• Regulatory aspects involved in the fund management process
• Expected code of conduct from the fund management professionals
• Role of the dealing room team
• Checks and balances between the fund management team and the
dealing room team
• Execution of portfolio decisions
• Implementation Shortfall’
• Introduction to Algo Trading
Dealing Room

• A dealing room is a place where shares, currencies, or commodities

are bought and sold.

• The dealers are there to facilitate trades on behalf of the fund. They
may act as principal or agent.

• Banks trading actively in the securities market and offering variety of

products usually segregate their dealing room functions into two or
three (which has become the current trend in large dealing rooms):
Dealing Room

• One, front office – that undertakes the actual dealing/trading

operations in the interbank market;

• Two, mid office – if established, is entrusted with the job of risk

management and accounting policies, MIS; market research, etc; and

• Three, back office – which is made accountable for settlement of

transactions, reconciliation and accounting
Expected code of conduct from the fund management professionals

1. Act in a professional and ethical manner at all times.

2. Act for the benefit of clients.
3. Act with independence and objectivity.
4. Act with skill, competence, and diligence.
5. Communicate with clients in a timely and accurate manner.
6. Uphold the applicable rules governing capital markets
Role of the dealing room team
• Dealing room should have adequate number of well attended phones
and the telexes, sound counselling about economic developments,
competitive quotes and capability to transact the entire amount of
securities requested by the fund manager.
• To manage the fund's position or inflows and outflows in to the fund,
so that each security exposure is kept at the desired level.
• To produce price-efficient trades so that the fund benefits from the
price movement.
Checks and balances between the fund management team and the dealing room team

• Dealers have to ensure that orders are executed on the best available terms,
taking into account the relevant market at the time for transactions, size of the
transaction, best interest of all the unit holders.
• They have to identify existing or potential conflicts of interest as per their
institutions policies and address the same and disclose all interests in securities as
required by statutory requirements.
• They cannot carry out any transaction on behalf of a fund with any counter party
who is an associate of the sponsor/AMC/fund manager/dealer/CEO unless such
transaction is carried out on arm's length basis.
• Dealers have to always communicate in unambiguous, transparent and accurate
manner and conduct all communication during market hours through recorded
modes and channels only
Execution of portfolio decisions
• Execution of any portfolio decision involves buying or selling a security and following aspects are
involved with it

i. Reference prices are used in determining trade prices for execution strategy and in calculating
actual trade costs for post- trade evaluation purposes.
ii. Decision price benchmark represents the security price at the time the portfolio manager made
the decision to buy or sell the security.
iii. Previous close benchmark refers to the security’s closing price on the previous trading day
iv. Opening price benchmark references the security’s opening price for the day
v. Arrival price is the price of the security at the time the order is entered into the market for
execution
vi. Closing price is typically used by index managers and mutual funds that wish to execute
transactions at the closing price for the day
Implementation Shortfall (IS)
• The implementation shortfall (IS) is the most important ex post trade cost
measurement used in finance. The IS metric provides portfolio managers with the
total cost associated with implementing the investment decision. This spans the
time the investment decision is made by the portfolio manager up to the
completion of the trade by the trader. IS also allows portfolio managers to identify
where costs arise during the implementation of the trade.
• IS = Paper return – Actual return
• The paper return shows the hypothetical return that the fund would have received
if the manager were able to transact all shares at the desired decision price and
without any associated costs or fees
• The actual portfolio return is calculated as the difference between the current
market price and actual transaction prices minus all fees
Implementation Shortfall (IS) - Example
• Implementation Shortfall A portfolio manager decides to buy 100,000
shares of RLK at 9:00 a.m., when the price is $30.00. He sets a limit
price of $30.50 for the order. The buy- side trader does not release
the order to the market for execution until 10:30 a.m., when the price
is $30.10. The fund is charged a commission of $0.02/share and no
other fees. At the end of the day, 80,000 shares are executed and RLK
closes at $30.65.
• 80,000 Shares were executed @ 30.30
Implementation Shortfall (IS) - Example
• IS = Paper Return – Actual Return
• Paper Return =(1lakh Shares * 30.65 Closing price) - (1 lakh Shares*30
Decision price) = Rs 65,000
• Actual Return = (80,000 Shares * 30.65 Closing Price) – ( 80,000
shares *30.30 buying cost ) – (80,000 shares * 0.02 Commission)=
26,400
• IS = 65,000 – 26,400 =38,600 Rs.
Introduction to Algo Trading
• Algorithmic trading is the computerized execution of the investment
decision following a specified set of trading instructions. An
algorithm’s programmed strategies used to electronically execute
orders will slice larger orders into smaller pieces and trade over the
day and across venues to reduce the price impact of the order. The
primary goal of algorithmic trading is to ensure that the
implementation of the investment decision is consistent with the
investment objective of the fund
• Trading algorithms are primarily used for two purposes—trade
execution and profit generation
Introduction to Algo Trading
• Execution algorithms. An execution algorithm is tasked with transacting an
investment decision made by the portfolio manager. The manager determines
what to buy or sell on the basis of his investment style and investment objective
and then enters the order into the algorithm. The algorithm will then execute
the order by following a set of rules specified by the portfolio manager.
• Profit- seeking algorithms. A profit- seeking algorithm will determine what to
buy and sell and then implement those decisions in the market as efficiently as
possible. For example, these algorithms will use real- time price information
and market data, such as volume and volatility, to determine what to buy or sell
and will then implement the decision consistent with the investment objective.
Profit- seeking algorithms are used by electronic market makers, quantitative
funds, and high- frequency traders