Be like Honda - Portfolio management as a production process

Systematic return management has a lot in common with running a factory. Return generation is a structured production process. Raw inputs such as macro and firm information as well as risk components are put together to provide a functioning product, the portfolio. This product is expected generate consistent returns with controlled volatility. Production quality is measured by whether the portfolio delivers the expected risk and return performance. The portfolio managers who are engineering the product try to create a repeatable process that prove consistent. Managers can improve returns by adjusting the production process.  Investors gain insight on the quality of the manager by monitoring their ability to implement an efficient production process. 

Honda Motors is one of the great automobile industry engineering success stories. Honda's success is based on the dynamic leadership of its founder, Soichiro Honda who focused on key principles for the firm's success. The core values of the firm are rooted in deep production knowledge and a questioning processes. For a great read on the firm, see Driving Honda: Inside the World's Most Innovative Car Company by Jeffrey Rothfeder. 

The key philosophical driver for Honda is sangen shugi, the three realities of "see it with your own eyes". While it did not originate with Honda, the firm has fully embodied these principles. The three realities are: genba, focusing on the real place where value is created; genbutsu, focusing on hand-on to go and see for yourself; and genjitsu, focusing on finding what is true through facts.  Knowledge comes from understanding local conditions. Know the details from the source. There is also the word monozukuri, the process of making things, which is critical to understanding what is built. 

To understand a car, you need to understand the making of the car. To understand portfolio management requires understanding the return generation process with deep detail. If you don't know all the processes for building a portfolio, you don't know the portfolio and you cannot deliver a good product.

Honda also developed the management idea of a "waigaya" or the group meeting to solve problems. But, this is not the same as just having a committee meeting. The waigaya is driven by four principles, all are equal, all ideas are disputed, the group owns the idea, and the group must come to a precise decision. These meeting can be controlled chaos but the idea is to focus on a problem and a solution and not on management structure. The lowest person in the group will drive the decision if it works. 

There, of course, is more to the success of Honda than just manufacturing philosophy. Some of their key management principles include:

• Focus on individual responsibilities
• Value simplicity over complexity
• Decide on facts not theory
• Minimize waste
• Keep the organization flat
• Employ autonomous and ad hoc design
• Engage in perpetual change
• Have cynicism of conventional wisdom
• Set unambiguous goals 
• Borrow freely from past innovation 

Now, close your eyes and think about these principles and the core idea of sangen shugi. These are all of the same ideals that you would expect from a high performing hedge fund or money management firm regardless of size.