The premise of reconciliation is simple. Check one thing against the other; when they match, you are done! Anyone familiar with reconciling position quantities in the firm’s accounting system to custodian records understands the process, and that’s part of the problem. Upon completing basic reconciliations of positions, many advisors feel they have done enough to generate accurate client reports. Our experience tells us that they are in for a rude awakening.
Basic reconciliation of positions is a great starting point, but it’s not enough to ensure accurate performance reporting. Here are 3 most common issues that will cause your performance to be off – even when the basic reconciliation is clean.
Reason: #1 Pricing
Prices are separate from portfolios and transactions, and you cannot just assume that those are clean. The price check is more involved than simply reconciling security quantities, because pricing isn’t black and white. The goal of your review is to get the pricing files as clean as possible. The more accurate the price, the more accurate the performance will be.
Here are some questions and points to consider as you review the pricing files
Do the prices make sense? If not, to what degree are they inaccurate?
If your common stock prices come from multiple sources (for example, a custodian or a third party), how significant is the difference?
Prices on fixed income securities will typically have a larger discrepancy than common stock prices.
Illiquid holdings such as private equities, hedge funds and interest limited partnerships have less frequent prices.They also tend to be more subjective. The more illiquid an asset, the less accurate the price will be.
Reason #2: Security Transfers
When securities are transferred in and out of portfolios, they must be valued properly. Incorrect market values on transfers of securities will distort performance. Greater differences in the market value will generate greater distortions in performance. In our experience, this security transfer valuation check is not facilitated within any leading portfolio accounting system, so it is often overlooked.
Reason #3: Corporate Actions
We think of corporate action as a single occurrence, but each corporate action consists of multiple transactions. It is common to see anywhere from 3 to 6 transactions per corporate action within a given portfolio, and that’s where mistakes can creep in. Each set of transactions pertaining to a corporate action must be processed correctly (i.e. net to zero value) to avoid creating a false net flow.
If a firm does not perform this check carefully, it risks creating an artificial income or loss amount and net flow within the portfolio. The only way to ensure accurate reporting of corporate actions across any number of portfolios is by conducting a transaction-level audit.
When completing this check, be sure to look carefully at both sides of each corporate action. That is the only way to validate that those actions do not create artificial income or loss amounts to be reported from within your accounting system!
Getting portfolio holdings and performance right is a difficult task. Depending on volume of transactions, reconciliation frequency and complexity of holdings, reconciliation is a commitment that can take several days of full-time effort. Firms put a lot of pressure on their staff to get performance right. After all, shouldn’t the internal team be able to avoid or catch all performance mistakes on their own? They are just checking sets of numbers against each other, so how hard can it be?
In reality, performance reporting is a highly specialized discipline. It has many nuances, and the technical details can get extremely complex. Even if your diligent staff gives it their best effort, an internal review of performance reports can be time-consuming, overwhelming and prone to errors. When you want to be sure that your performance is accurate, you must combine expert knowledge with the backbone of a tried-and-tested set of procedures.