- Transactional compliance focuses on individual transactions, while portfolio compliance considers what is best for a client's overall portfolio in light of their goals. - Strategic compliance aims to integrate compliance vertically throughout the entire investment process, from establishing a client's preferences upfront to ongoing portfolio monitoring. - This allows compliance to guide the investment process from the beginning and ensures a client's portfolio continuously aligns with their preferences. It also aims to simultaneously meet organizational, advisor, and client needs.

1. Can Strategic Compliance
Become a New Standard?
BESTPRACTICECLIENTSERVICEMAY2010

2. Can strategic compliance become the new standard? | May 2010 01BESTPRACTICE CLIENTSERVICE
Q. We’re starting to see a shift from “transactional” compliance to “portfolio-based
compliance” in wealth management: What does this actually mean?
SH: Before considering the implications of this shift, it’s important to establish a
lexicon of sorts as misleading terminology can bury the key points.Transactional
compliance is the utility within wealth management currently employed to
implement buying and selling decisions consistent with a firm’s highly skilled,
professional investment research.
The wealth management industry uses the transactional compliance utility in two
key ways: to ensure transaction-based consistency with in-house research views and
as a quality assurance standard (for which the Approved Product or Recommended
Research Lists are the primary tools). Financial advice offered in accordance
with an APL or recommended list forms the basis of compliance and, with that, a
quantifiable risk management discipline.
However, transactional compliance does not, and cannot, consider what is in the
best portfolio-specific interests of individual clients.This is where portfolio-based
compliance becomes important.
Q. So where does portfolio compliance come in?
SH: The investments comprising a client’s portfolio could actually be entirely
compliant with a firm research’s recommendations, or with its APL, but be
disconnected from what might be in the specific client’s long-term interests.
Potentially, one could encounter a situation in which a client has a fully compliant
portfolio from a research or Approved Product viewpoint, but the mix of securities
does not actually support the client’s highly individual, long-term goals.The potential
for strategic shortfall in the composition of a client’s portfolio is an issue of portfolio
compliance.
What we’re really talking
about is ‘cradle to grave’
compliance – vertically
integrated at all points
of the investment
management process.
A sustainable process
cannot be built around
exceptions.
‘Strategic’ and ‘dynamic’ are not adjectives one automatically associates with compliance in wealth
management. Given that the objective of compliance is, and must be, to ensure portfolio managers
do not breach prescribed investment parameters, compliance is a limiting function. In generally being
applied as a check of a transactional, or product-based, decision already made, compliance has been a
tactical tool. However, transactional and product-based compliance is now being extended into a new
paradigm of strategic compliance.With the advent of smart, flexible technology, compliance can be
moved to the front end of the investment process and applied throughout as a client-tailored overlay.
Beginning with the client’s own rules, preferences and constraints, strategic compliance is that which is
vertically integrated throughout the entire investment process. In the third instalment of our discussion
series, Stuart Holdsworth considers how strategic compliance aligns, in a way that has not been
achieved previously, organisational needs with those of the client and the wealth adviser.

3. Can strategic compliance become the new standard? | May 2010 02BESTPRACTICE CLIENTSERVICE
Investment professionals agree that no single security has long-term predictability.
You can really only get meaningful predictability from a broader, diversified pool.
Over time, investment security selection within a sector will not be a consistent area
of outperformance in portfolio management. Certainly, one gets exceptional stock
pickers but they are just that – exceptional. A sustainable process cannot be built
around exceptions.
To this end, an increasing portion of wealth management professionals are adopting
an asset allocation approach which mitigates the effect of security and region-
specific risks as an effective framework for portfolio construction.
Q. So asset allocation and portfolio compliance are synonymous?
SH: Almost. Returning to the importance of our lexicon for the moment, it would
be more accurate to say that asset allocation drives, or results in, a portfolio
compliance utility. It is important to note that this utility is complementary to that of
transactional compliance.
The combination of these two compliance utilities – simultaneously and
continuously applied – will result in a new level of client-centricity we have not seen
before. Client-centricity is largely risk and time profiled.With risk and time profiling,
this generally means working out an allocation of assets that achieve the correct
balance with a correspondingly greater level of certainty.
Q. What are the elements required for asset allocation and, resulting from it, a
portfolio compliance utility?
SH: A vital constituent in the asset allocation process is clearly a model portfolio:
However, it is important to introduce model portfolios which are actually PRE-
compliant in both their individual security selection and asset allocation. A model
portfolio can be pre-compliant at a portfolio level in its asset allocation by being
constrained to the parameters of a client-compliant asset allocation framework.To
be specific, the client’s rules, preferences and constraints are directive in the setting
of the end portfolio.
Using pre-compliant models and client-compliant overlays, portfolio rebalancing
operations will yield an immediate and transparent compliance.This is achieved
by using a continuous client-centric overlay on top of all asset allocation model
decisions.What we’re really talking about is ‘cradle to grave’ compliance – vertically
integrated at all points of the investment management process.
You score a portfolio
management Bull’s Eye
when your process starts
with your client’s highly
individual preferences
ahead of ANYother
consideration.

4. Can strategic compliance become the new standard? | May 2010 03BESTPRACTICE CLIENTSERVICE
Q. Compliance, vertically integrated at all points of the process – what does that
look like?
SH: Given that we’re all comfortable with the idea of hitting targets in investment
management, imagine a multi-level target which includes all aspects of the
investment process within your firm’s current compliance regime. From the outer
ring, you have fundamental compliance with ASIC licensee requirements; moving
in one ring, you achieve transactional compliance through research and adherence
to your firm’s recommended list or APL. You achieve portfolio-based compliance
in the next inward ring with the use of model portfolios and broad asset allocation
guidelines used as an overlay to the client’s portfolio. However, in the innermost ring
– the Bull’s Eye – the overlay is a client-specific one.
You score a portfolio management Bull’s Eye when your process starts with setting
your client’s highly individual rules, preferences and constraints in advance of any
other consideration.
This is the emergence of strategic compliance. If the research is being applied in
the specific interests of the individual client, not only is this something to keep the
license holder or regulator happy, it will be inherently good for the client.The quicker
adjustments can be made to individual portfolios consistent with robust research,
the better it will be for the client AND the firm. Strategic compliance can provide a
demonstrable, quantifiable and measurable improvement in client service.
Q. So strategic, portfolio-based compliance requires an overlay of the client’s own
individual requirements?
SH: Yes, portfolio compliance introduces a continuous application of the client’s
individual agenda over the broader investment process as an overlay.Whilst an
adviser might agree with a preset asset allocation range, this might have to be
overridden with client-specific instructions. If these instructions are applied after a
portfolio review, compliance and meeting the client’s long-term goals become time-
consuming and difficult.
As research recommendations change in volatile markets, a wealth management
practice that employs strategic compliance can take comfort that, when
checking client portfolios for compliance, the research is also being implemented
instantaneously and consistently across an entire client base. As a result, every
individual client’s needs – even though all these needs will be a little, or a lot,
different – are considered equally.
By mixing these tools
in a slightly different
way with slightly more
sophisticated technology,
we can produce a business
redefining result with
some extraordinary
implications....

5. Can strategic compliance become the new standard? | May 2010 04BESTPRACTICE CLIENTSERVICE
Q. So, clearly, we need a system which will allow a client’s overlay to be established
in advance and able to run continuously?
SH: Yes, it’s imperative to deploy technology which allows a client’s rules,
preferences and constraints to be set first: Further, it must also rebalance
automatically around the client’s pre-defined framework every time a change is
made.
To be more explicit, essentially, three functionalities are required: first, the system
must allow advisers to enter rules, preferences and constraints that clients instruct.
Second, the system must allow you to enter and adjust the asset allocations
associated with each individual client.Third, the system must allow you to input and
maintain model portfolios in all their permutations.These three capabilities need to
interact with each other not sequentially, but simultaneously in a single, continuous
process to achieve strategic compliance. Each function of the system is critical in its
own right.
However, only when they are working interdependently and simultaneously can we
achieve client-centric portfolio management which is at the centre of the target to
which I referred earlier.
Q. Strategic compliance sounds a little like alchemy.
SH:Well, to a certain degree it is.We are taking several basic processes and,
by combining them, we can produce something far greater than the sum of the
individual parts.
For example, we’re talking about fundamental tools being used right now – portfolio
modelling and compliance checking. By mixing these same tools in a slightly
different way with more sophisticated technology, we can produce a business
redefining result with some extraordinary implications. Central to the philosophy
of strategic compliance is the establishment of a clear, flexible client investment
framework.The tension and the friction that builds inside a traditional transactional
compliance model can now be overcome with a strategic approach which aligns
simultaneously the interests of the client, the wealth adviser and the business. From
a risk managed point of view, a wealth adviser can establish and maintain an asset
allocation that’s consistent with the client’s investment profile and goals. If this is
done at the outset of the client’s investment process and monitored consistently, it
reduces risk for the client, the adviser and the firm simultaneously.
Compliance should no longer be a biannual or quarterly check done ‘after the fact’ on
an investment portfolio. By accessing overall strategic compliance when the client’s
rules, preferences and constraints are being discussed as part of their overall goals,
compliance can act as a strategic guide for all suggested investments.

6. Can strategic compliance become the new standard? | May 2010 05BESTPRACTICE CLIENTSERVICE
Q. So strategic compliance requires a step beyond model portfolio and portfolio
rebalancing capability?
SH: A lot of people talk about having model portfolio capability. Model portfolio
capability is a necessary but not sufficient ingredient to achieving strategic
compliance and, by extension, client-centric service.
It’s about being able to combine the model portfolio capability with the ability to
maintain and adjust asset allocation and client specific instructions at a tactical
level.This is a very important point. It’s not about the model defining a product.
The model is just a component in the provision of a portfolio management service.
You might have multiple models for each asset allocation scenario.The relative
weightings of each asset allocation situation are determined according to the
client’s unique risk profile.
It’s not just about portfolio rebalancing and it’s not about operating within a
standard compliance framework. It’s about having them interact within a client-
centric asset allocation framework – remaining in the centre of the client’s portfolio
management target. In this way, a wealth management group using strategic
compliance can demonstrate rapid, flexible servicing of clients as well as meeting
transactional compliance obligations.
Finally, it’s important to note here that we are not simply talking about one-at- a time
tailored client overlays.We are talking about being able to apply an individualised
approach in a mass framework: Strategic compliance is also fully scalable
compliance.
Q. Can you give an example of scalable strategic compliance?
SH: If you have an allocation to Australian Equities but must, for whatever reason,
exclude a big stock in that sector, this will have significant implications for the
client’s allocation adjustments. If these adjustments are not facilitated continuously
in advance, the implication is that you are going to be scrambling with manual effort
at the end of each decision-making cycle.This is not efficient and impossible to scale
with large numbers of client portfolios.
If we are to achieve genuine best practice in client service in wealth management (eg
that which addresses the client’s individual requirements continuously), portfolio
compliance demands on-going obligation to portfolio review.With that, there is
a new level of scrutiny and, as a result, greater level of client comfort around the
portfolio.

7. Can strategic compliance become the new standard? | May 2010 06BESTPRACTICE CLIENTSERVICE
Q. So strategic compliance allows you to achieve a number of formerly competing
goals simultaneously?
SH: Compliance, client service and portfolio management are all aligned and become
the same thing. By servicing the client strategically, you understand a combination of
their asset allocation compliance and the client overlay compliance. By looking after
your clients first, you can reduce your own business risk and that of the broader
organisation. In order to be truly demonstrating that you are acting in the client’s
best interests, you have to be highly proactive in monitoring – and that means
rebalancing even within test scenarios – the client’s portfolio.The parameters of
the client’s individual investment framework may shift many times in a year, or
even in a month, either as markets change or as the client’s circumstances change.
However, strategic compliance ensures that change, and resultant rebalancing, is a
streamlined exercise.
Best practice compliance means considering the client’s rules in an ‘overlay’ process.
Best practice client service results from the deployment of a strategic compliance
standard.
Q. Somewhat paradoxically, it sounds like strategic compliance might even save
time compared to traditional, transactional compliance?
SH: This is another vital point.The process of strategic compliance checks within
defined asset allocation parameters and model portfolios can be systematised
using new technologies.Therefore, it can be performed by anyone in a fraction of
the time currently required by checking spreadsheets in a transactional compliance
environment.
You can even place the onus of compliance back to those who service the clients
if desired. Advisers can execute their own compliance checking in a continuously
strategic manner. Or, the process can be managed through a centralised group as
preferred.
Deploying a strategic compliance standard saves huge amounts of time for wealth
advisers with regular transactional compliance checks.The real shift here is that
compliance goes from being a point in time (or static) check to a continuous, dynamic
part of the portfolio management process itself.
By looking after your
clients first, you can
reduce your own business
risk and that of the
broader organization.

8. Can strategic compliance become the new standard? | May 2010 07BESTPRACTICE CLIENTSERVICE
Q. So won’t the infrastructure required to maintain such a compliance regime
stretch existing systems to breaking point?
SH: Most existing systems with a basic modelling or compliance checking capability
will definitely be over-burdened and most likely ineffective. If you look at the
current techniques embedded in portfolio management applications, they generally
support compliance focused on point of sale, transactional compliance, or product
compliance. For example, has Ystock actually got a Buy recommendation on it
and has client X not excluded it?That’s the traditional approach to compliance in a
transaction-dominated world.This is not the basis for a scalable business model and
therefore has limitations.
Q. So what are the technology implications of achieving strategic compliance?
SH: The technology implications are significant. Enhanced systems are required for
entering and codifying the research as well as client instructions. New systems able
to apply model portfolios and client specific overlays are also necessary. Finally, new
systems are required for continuous monitoring and executing this in an automated,
seamless manner.
The technology needs not only to codify the research into manageable, deployable
“bits” but also to ensure that portfolio assets can be assigned to each asset
category.Technology capacity is also needed to monitor portfolios against changing
asset allocations and, indeed, changing client circumstances which may cut across
existing asset allocations.
The good news is that cost-effective technology to address these requirements is
available in our market now and already facilitating the sustained delivery of this
kind of compliance.
Q. Can strategic compliance genuinely mitigate business risk?
SH: True client-centric service means being strategically proactive inside your
clients’ portfolios. It means running tests on their portfolios regularly to assess
transactional and portfolio compliance balances.Traditionally, and typically due to
conflicts of interest, we had compliance and advisory almost pulling in opposite
directions with the client somewhere in the middle. If stakeholders are pulling in
different directions, that will introduce a level of risk in, and of, itself.
If a portfolio differs from its ideal, a stakeholder (whether it be client, wealth adviser
or the firm) is carrying an unnecessary degree of risk. Remaining fully cognisant of
portfolios requiring attention in the context of the client (not just a model portfolio)
is the most effective means of reducing your investment-directed business risk.
Best practice client
service means being
strategically proactive
inside your clients’
portfolios.

9. Can strategic compliance become the new standard? | May 2010 08BESTPRACTICE CLIENTSERVICE
Being able to demonstrate and achieve this continuously combines a reduction in
business risk with best practice, client-centric service.
So strategic compliance checking and client tailored portfolio rebalancing theory
actually become the same thing. Client tailored rebalancing itself becomes the
measure of compliance. If I’m calculating the rebalancing of a client tailored portfolio
and there’s an adjustment to be made, then something is out of step: whether it be
client compliance (client service risk) or house compliance (business risk). If a client
tailored rebalance calculation reveals that nothing needs to be adjusted, then we
know we have acted entirely inside the client’s own parameters. No further cross-
checking is needed and the interests of all stakeholders remain aligned.
Q. So, consistent with the move towards client-centricity, compliance might
address the client’s specific needs as opposed to just satisfying the regulatory
needs of an organisation?
SH: Yes, that is the direction we’re headed. It’s important to note that, even from
the organisation’s point of view, that’s a desirable outcome. Also, what this means
in terms of compliance is not the nightmare one might expect. Organisations must
merely adopt a compliance regime that focuses not at the point of transaction, but
rather, begins with the client. For a wealth adviser, this is an on-going obligation
embedded in every aspect of managing the client’s portfolio – from conducting
the Needs Analysis to the first SOA and on-going review.Whilst the client’s
portfolio should not move beyond the boundaries of a firm’s APL or set of research
recommendations (eg the outer limits of the portfolio target defined earlier), it
could have infinitely more flexibility within. Strategic compliance provides us all with
a clear, quantifiable means of repeatedly scoring that Portfolio Bull’s Eye.
Just because a decision is compliant with the legally sanctioned ‘house’ view, does
this mean it is aligned with the client’s best long-term strategic interests? Are
decisions enabling the investment process to remain in the centre of the client’s
portfolio target area at all times? In the wake of the GFC, that is the question
needing an answer.
Strategic compliance
provides us all with a
clear, quantifiable means
of repeatedly scoring
that Portfolio Bull’s Eye.