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Compliance Like It's 1959

Fifty years ago, quality control in manufacturing meant inspecting what came off of the assembly line and throwing out bad product.


A simple path to higher quality was to employ more inspectors and reject more product. High quality was expensive and higher quality was more expensive.

Since then, most manufacturers have adopted “lean production,” an innovation which is usually attributed to Toyota.  

Toyota set out to eliminate defects at their source. This would increase quality. And decrease costs. They’d need fewer inspectors and they’d spend less time repairing defects. It worked. In the 1980’s European luxury car manufacturers spent more time just fixing defective cars coming off the assembly line than Toyota spent altogether to manufacture cars that were of a higher quality.*

Today’s portfolio wealth management compliance is like 1950s manufacturing quality control. More compliance means more reports and more reviews. That's bad. The good news is that the same level of more-for-less efficiency that lean production brought to manufacturing is possible with compliance and in much the same way: design your wealth management workflow so that compliance is “built in” — not just an extra layer of oversight. There are five key things to making this happen:

  1. Parameterize customization criteria. Clients will demand customized, tax-managed solutions. However, customization should be parameterized, that is, stored as structured data, not free-form notes.
  2. Automate “data integrity” checks on customization parameters to make sure they’re not an accidental path to non-compliance. For example, put limits on asset class customization (it’s OK to adjust Real Estate Allocation from 5% to 10%, but it’s not OK to make Real Estate 95%), and limit substitutions to like securities (it’s OK to replace a Large Cap fund with a Large Cap ETF, but not with a Small Cap ETF).
  3. Automatically link client responses to your risk profile questionnaire to a permitted set of asset allocations.
  4. Create a direct link between the profiling system, which captures the customization parameters and the target asset allocation, and the rebalancing system.
  5. Automate review and rebalancing. Review every account daily and, as appropriate, rebalance to bring the portfolio in line with its customization parameters and the firm’s investment recommendations. This is a process that can be largely automated.  

These five steps complete the creation of an automated “compliant loop.” It means every portfolio not only has an appropriate target and appropriate customization parameters, it guarantees that every portfolio adheres to the customization parameters of the profiling system. It can also guarantee that every portfolio will follow the guidance of the Investment Policy Committee. In this way, compliance becomes largely automatic. Overall portfolio management costs go down and compliance goes up.

Call it lean portfolio management. It's compliance like it's 2017.

*The Machine That Changed The World


For more on this topic, check out Can Compliance be Automated?


President, Co-Founder