Continuous Improvement

I finally had to pull myself out of bed at 2am this morning so I could get out what's on my mind. Hopefully I do not have too many typos...its dark and the only light here illuminating my keyboard is my laptop monitor.

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My work on developing managed portfolios and the associated fee structures will hopefully be completed by mid next week. As I am sure you can appreciate, the development of these portfolios is a large task and even upon their completion, the evolution and continued improvement upon them will be a never ending process.

While working as an quality auditor for a professional audio manufacturing company years ago, the initial process for my audits was to set aside a number of samples of a finished product and perform a cosmetic (outside) and functional (inside) inspection. When these audits exposed a reoccurrance of cosmetic or functional problems, it was then my job to document my findings and pass the data on to the product manager. From here, the product manager would find out who was associated with the mistake and tell them to stop making it. Because machines did not assemble the majority of the finished product, human error was inevitably going to happen over and over despite a slap on the wrist...or even worse, writing someone up for...well, being human. It was a ridiculous way to control our product quality and minimize employee mistakes. What could we do?

Japan is well-known for having efficient manufacturing processes and some of it has to do with how they collect data from the employees who work on the assembly line, for example, and implement "mistake-proofing" mechanisms in order to prevent human error from becoming an quality issue. This is called, "Poka-Yoke" and was one strategy we trained the mechanical engineers, product managers, and employees to implement.

Another Japanese manufacturing process we implemented was "Kaizen", which means continuous improvement. While this philosophy sounds like a no-brainer, believe it or not, continuous improvement is not an easy task to implement in work and/or life. And if it is implemented, how do you effectively track that a change did in fact result in an improvement? The short answer is that data must be continuously compiled and analyzed. If analysis proves that something is wrong and needs tweaking, then it is time to brainstorm with those involved to come up with an idea that will fix the issue. This process should continue forever until perfection is achieved.

So how does my background in Poka-Yoke and Kaizen relate to managed portfolios? In a nutshell, I wanted to convey that these processes I helped implement in a manufacturing environment will also be utilized in my managed portfolios. I want the managers and research teams, investment choices, tools, strategies, etc. to improve with time. I want your assets to age like a fine wine where the taste gets better and the price tag goes up.

Another question I may get is why I will only have 5-6 managed portfolios. I'll address that so everyone understands why this is so important.

Nearly all financial advisers have custom portfolios for each client. Sounds great at first, right? In reality this creates a significant disadvantage to both the client and adviser. Here's why: if an adviser is managing 300, 500, or maybe 700 portfolios, how the heck can one adviser keep track of all that data to make continuous improvements and help each client effectively manager their assets? It is nearly impossible.

I had a lunch meeting this week with a local financial adviser who explained how she struggles with this issue. Unfortunately, due to the inflexible nature of her broker-dealer and business platform, her best solution is to put clients into what are typically known as "Fund-of-Funds" mutual funds. These funds are put together by [open-end] mutual fund companies to diversify investors' money [according to risk tolerance]. These funds are great for an adviser (or investor) who doesn't have the time to personally manage the money, or better yet, if they don't know how to manage various investment options, mutual fund managers will do it for you. Now an investor only has to buy one mutual fund if they want a "diversified" conservative portfolio, for example. Sounds good, right? Well there are pros and cons to these open-end mutual funds...but to get back to my point, this adviser and her clients hope that the managers managing these fund-of-funds are doing an excellent job at it. The huge issue is not with these particular funds, it is the inherent inflexible natural of open-end mutual funds. If you own a mutual fund read the objective of that mutual fund next time the prospectus arrives in the mail. Avoid the tendency to recycle it just this one time. The objective you read is the "box" the mutual fund manager(s) must confine themselves. If the manager wants to change the objective it must have the approval of the fund family and get shareholder approval through a proxy vote. This could take awhile...and is one reason why many open-end mutual funds are suffering terribly in this market environment. Luckily, some entrepreneurial money managers decide to move on to start hedge funds, or to become RIAs, so they can manage assets in an environment that stimulates creativity, has unlimited flexibility, and continuously improves.

This is extremely important to understand because most mutual funds are only set up to (hopefully) give an investor a positive return when the market is in an upward trend. Unless you've been sitting on the beaches of the Bahamas for two years straight without a newspaper, the Internet, or human interaction, you've noticed that the stock market is not in an upward trend. This is why most investors who are mostly in mutual funds are suffering badly.

My solution is to offer clients investment strategies that include the input and expertise of multiple money managers and researchers in order to give clients an edge well beyond buying individual stocks or mutual funds.

So, the intent of these portfolios is not to put clients in a box and limit flexibility. The true purpose for the managed portfolios is to have a streamlined process for various levels of risk tolerance so we can navigate swiftly and effectively through this market environment and make continuous improvements along the way.