Building Funds By Module

April 07, 2014

In recent years a quiet revolution has taken place in the automotive industry. While continuing to produce cars under different brand names, manufacturers have focused on using common modules as the core components of each vehicle.

Open the bonnet of a typical front-wheel drive car from the VW group, for example—whether an Audi, Seat, Skoda or Golf—and you’ll find a single type of engine, crankshaft, clutch, ventilation and infotainment system. VW is extending its modular manufacturing platform, called MQB, even to its luxury marques like Porsche and Lamborghini.

The modular approach enables companies to cut costs and increase flexibility, while retaining distinct design elements for different brands. Modular manufacturing also helps companies avoid having to reinvent the whole production process when client demand changes.

Building block-based design is also common in several other economic sectors, including computer hardware, programming, power systems and high-rise buildings.

But in finance and investing, at least until a few years ago, complexity was not something to avoid: it was the name of the game.

Above all, the 2008/09 financial crisis was a story of overly complex products. They were sold by banks, whose senior executives didn’t understand the products, to investment firms, whose portfolio managers couldn’t value them.

The more opaque features a product designer could add on—options, hidden or disguised correlation and credit risks—the greater the profit margin and the higher the year-end bonus for the distributor.

Even the banks themselves have become “too complex to price”, Andrew Haldane, executive director of the Bank of England, said in 2012.

Things are beginning to change, however, and not just because regulators have started to crack down.

After a decade and a half of low returns from equity markets and in an environment of ultra-low bond yields, many investors are rethinking their approach to portfolio construction.

“In finance you still have a lot of actors and huge levels of complexity,” Jerome Morin, a structurer at investment bank Citi and formerly a nuclear physicist, told

“Previously there may not have been many external drivers to change the ways people were doing things, but since the financial crisis there’s been a big emphasis on cost reduction and efficiency. Look at the recent growth of low-cost operators in asset management. Portfolio performance is increasingly driven by macro factors and people are trying to identify them. There’s a big cultural shift going on.”

Morin points to the car business as a paragon of the building block approach that finance could emulate.

“The automotive industry is the most advanced in terms of the modularisation of processes,” said Morin.

“The idea is to split a system into its different parts and to try and reduce the interdependencies between those components. You then produce the components separately, using different subcontractors.”



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