Trade Allocation

Trade allocation is the step in which an investment manager divides an executed order among the individual client accounts or funds on whose behalf it was placed. Managers who run many portfolios with similar strategies usually combine their orders in the same security into one block trade, because a single large order is cheaper and simpler to execute than dozens of small ones. After execution the block has to be broken down so that each account receives its share of the securities and pays its share of the cost.

Allocation is the first post-trade step on the institutional side of the market. The executing broker cannot issue account-level confirmations or arrange settlement until it knows which accounts are involved, so allocation comes before trade confirmation, trade affirmation and settlement. It is also a conduct matter: because the manager decides who gets what, regulators treat the fairness of allocation as part of the duty owed to clients.

A portfolio manager decides to buy or sell a security across a group of accounts. The order management system records the intended quantity for each account and sends one combined order to the trading desk and on to a broker. When the order is filled, the broker reports the execution, often as several fills at different prices during the day. The manager then sends the broker allocation instructions listing each account, its quantity and its settlement details. The broker books each allocation as a separate trade and confirms it.

Accounts in a block normally receive the same average price, so that no client is favoured by receiving the better fills. Commissions and fees are shared in proportion to quantity. The settlement details for each account, held as standing settlement instructions in shared industry databases, identify the custodian bank and the account to which securities and cash must be delivered.

The principle applied in most markets is that the split is decided before the order is placed and followed afterwards. Common methods include:

• Pro rata. Each account receives a share of the executed quantity in proportion to its share of the original order. This is the default method, particularly when an order is only partly filled.
• Minimum size adjustments. Where pro rata would leave an account with an uneconomic or odd-sized holding, the manager's policy may allow small positions to be rounded up or excluded.
• Rotation. For thinly traded securities or limited offerings, accounts may take turns to be filled first.
• New issues. Shares received in an oversubscribed offering are divided under a specific policy, since IPO allocation by the bookrunner rarely matches what the manager asked for.

The abuse that these rules are meant to prevent is often called cherry-picking: waiting to see how a trade performs during the day and then allocating profitable trades to favoured accounts, such as those paying performance fees or the manager's own account, and losing trades to others. Regulators in the United States, the United Kingdom and elsewhere have brought enforcement cases on this basis. Firms are expected to have a written allocation policy, to time-stamp intended allocations, to document any departure from them and to review allocation patterns as part of compliance monitoring. Allocation fairness is closely related to the duty of best execution and to the handling of a cross trade between two clients of the same manager.

Late allocations delay everything that follows. Under a two-day settlement cycle, many managers allocated on the morning after the trade. With the move to next-day settlement in the United States in May 2024, industry guidance called for allocations to be sent on the trade date itself, early enough in the evening for confirmations to be affirmed before the depository's cut-off. European rules under the Central Securities Depositories Regulation likewise require professional clients to send allocations and confirmations to their investment firms within set deadlines, and the planned European move to T+1 in October 2027 has tightened expectations further.

Automation is the usual answer. Electronic allocation messages sent directly from the order management system, central platforms that match the manager's allocations with the broker's records, and enriched settlement data reduce the delay between execution and trade matching.

In listed derivatives, a block executed by one broker may be given up to the clearing brokers of the underlying funds, and allocation to accounts must happen within the time limits set by the exchange and the clearing house. In over-the-counter derivatives and foreign exchange, a manager may execute one trade with a dealer and then split it by fund, each piece becoming a separate contract under that fund's own documentation.

Operational risks include allocating to the wrong account, breaching an account's investment restrictions, and sending incomplete settlement details, each of which can cause a settlement failure or a compensation claim. Typical controls are pre-trade compliance checks, automatic comparison of executed and allocated quantities, reconciliation of positions with custodians on the following day and independent review of any allocation changed after execution. These tasks are a routine part of investment operations.