Unraveling the complexity, settling trades in Trade Operations

In APFC Perspectives by Paulyn

When it comes to investments, how familiar are you with custody? A custodial relationship for investment management is a relationship in which a designated agent is given a layer of control to assist the owner in transacting and safekeeping their assets. The Permanent Fund’s stocks, bonds, treasuries and other investments aren’t physically or digitally stored in the APFC office in Juneau, Alaska. A custodial bank holds these nearly 17,000 unique investments that span the globe, representing 28 currency denominations deposited in more than 700 bank accounts on behalf of the Alaska Permanent Fund. Though these assets are held in custody, APFC’s Trade Operations team, in partnership with the rest of the Finance Department, is responsible for ensuring that they are reconciled and processed to support the investment decisions of the Alaska Permanent Fund Corporation’s portfolio managers.

Understanding the custodial relationship is fundamental to comprehending how many of our in-house public market activities are processed within the global financial system. The actions, workflows and protocols related to these activities can be referred to as the lifecycle of an investment, beginning when a portfolio manager agrees to buy an asset and ending when they decide to sell it, or the asset matures, and everything that happens in between. While portfolio managers might receive due recognition for making decisions to enter into specific investments, the staff working in Trade Operations are responsible for ensuring that these transactions are completed efficiently and that those assets are monitored throughout their lifecycle. APFC’s Trade Operations, also known as the middle office, processes thousands of public market investment transactions every month, including fixed income products and public equities.

Settling trades, clearly complex

When the Alaska State Legislature established APFC to manage the assets of the Alaska Permanent Fund in 1980, the Fund was only invested in United States Treasury securities and investment-grade corporate bonds. One of the few portfolio managers would pick up the phone and make a trade with a counterparty. Once the seller and buyer of the asset came to an agreement, they would work with the custodial bank to settle the transaction with the counterparty. Records were kept locally in handwritten ledgerbooks.

Since then, the Fund has become increasingly complex and is now invested across eight asset classes, with nearly 60% of all funds allocated to public markets. Far from the days of a simple phone call, APFC’s Senior Investment Operations Analyst, Alex Smith, gives an example of what a global trade might currently look like, “Our Global Rates Portfolio Manager will enter into a purchase agreement with an Asia Pacific-based broker for a sovereign bond issued by the Republic of Hungary denominated in Japanese yen. Another Portfolio Manager will execute a foreign exchange transaction to trade US dollars for Japanese Yen to fund the purchase executed on the bond’s settle date. Our team will ensure that the trade details and settlement venue align with the counterparties. Two days later, the foreign exchange transaction will settle, and the bond will be received in exchange for Yen at the central European exchange in Brussels, Belgium.”

Though securities from one country denominated in another currency sound complex, they are frequently traded products, and the process that Smith explains is what is happening every day within the complex global financial system. For every Fixed Income transaction, there is a seller and a buyer; sometimes, the seller is a municipal government like Anchorage or Juneau, who sell bonds to fund local projects. Sometimes the seller is the central bank for a sovereign nation or a corporation trying to raise capital for various reasons. Once a buyer agrees on a price with the seller, they use ‘delivery vs. payment’ (DVP) or ‘receive vs. payment’ (RVP) methods through a settlement channel that transfers the bond from the custodial bank of the seller to that of the buyer, thus settling the trade.

The time between trade date and settlement date is referred to as the settlement cycle. For US stocks, corporate bonds, and foreign exchange transactions, settlement happens on the 2nd business day after the trade date. For US Treasury securities, options and commercial paper, the settlement occurs on the business day following the trade date. During this limited period, Trade Operations must communicate with all of the involved parties to ensure that the components of the trade align and address any differences that might arise.

Steady through the storm

“It is easy to undervalue the contribution of Trade Operations,” says Valerie Mertz, APFC Chief Finance Officer, “because when they are operating at peak efficiency and effectiveness, trades are settling as they should, and no one notices.  However, it is undeniable that this function is essential to the effective management of the Fund.”

Keeping an eye on all of the moving parts, providing mission-critical technical support for internal trading systems, and managing financial complexity could require a large team; however, working efficiently, APFC’s Trade Operations has traditionally been comprised of three people. When markets are calm, most processes are automated and work smoothly with oversight and troubleshooting by the team. Volatile market periods highlight the benefit of having an internal Trade Operations team, according to Smith, who explains that “at the onset of the pandemic in March 2020, many of our counterparties had communications issues, with some becoming completely unresponsive. We were able to use our various communication channels and relationships with APFC’s portfolio managers and their broker contacts to make sure that we could quickly confirm and diagnose issues.”

“Having an operations team in-house allowed us to react nimbly,” says Smith, who noted that APFC could have faced significant losses in 2020 had we not been prepared, “efficiently settling portfolio managers’ trades helped to avoid a nasty liquidity crisis where securities and cash might not clear to fund other trades.”  Essentially, when an APFC Portfolio Manager recognizes something big is shifting in the markets and wants to sell some assets to “risk-off,” the speed in processing and completing trades is vital for ensuring sufficient liquidity to pivot and engage in another transaction quickly.

“When Trade Operations efficiently, competently and professionally performs their duties, it enables the Investment Team to focus on the portfolio management and security selection activities that can drive the value add.” Says Marcus Frampton, APFC Chief Investment Officer, “APFC’s internal trading of fixed income and equities has added hundreds of millions in value to the Fund over time based on outperformance of assigned benchmarks.

The Future of Trade Settlements

Smith says, “Not very long ago, team members were spending a lot of their day making edits, printing instructions to be signed with wet ink, performing time-consuming manual reconciliations, etc.”  It was a lot of administrative work, large volumes of data entry and comparing values on spreadsheets. When Smith joined the desk in 2018, they were still required to use “wet-ink” signed documents physically mailed and faxed between counterparties and the custodial bank. Since then, APFC’s partner workflows have transitioned entirely to machine language protocols, email, and digital certification.

Processes in the last few years have measurably improved, and now Trade Operations has more tools to analyze and diagnose exceptions while ensuring that there are checks and tests in the system. Ultimately, efforts to modernize infrastructure have enabled Trade Operations to be more scalable and operate smoothly, whether assets under management are around $80 billion as they are today, or $280 billion, as we hope they will be in the future.

At APFC, Trade Operations is responsible for maintaining internal securities data and monitoring market feeds for corporate action events, alerting Portfolio Managers when action is needed. They also maintain a close relationship with investment system providers on development initiatives and ensure Portfolio Managers have rapid support for technical issues. Smith is proud of the Trade Operations team for retaining a deep knowledge of financial infrastructure and the ability to solve complex issues, all while handling thousands of investment-related transactions every month, an amount which continues to increase steadily.

For their work enabling the investments team to focus on portfolio management, Marcus Frampton recognizes that “APFC’s Trade Operations colleagues have performed admirably, and are valued members of the team as we strive to continue delivering value to the Fund’s stakeholders going forward.”

Having efficient and effective Trade Operations requires commitment and resources from the Corporation, and APFC has supported these efforts for many years. All of this work is to ensure that the assets of the Alaska Permanent Fund are secure and well managed for the benefit of Alaskans now and in the future.