The Future of Investing (Part ii)

Modularisation, standardisation and automation: a cost-efficient way of customised mass production

Even though digital services are naturally easier to customise with minimal costs, personalised, bespoke products and services inevitably bring additional costs and lower efficiency. In the manufacturing area, personalisation has meant made-by-hand so far, and customization still often comes at a premium. To satisfy individual customer requests while remaining cost-efficient, it is essential that companies develop customer-focused business models and employ intelligent, versatile production technologies.

Maintaining overall plant efficiency is the objective of customer-oriented mass production (mass customization). The critical factors of availability, performance and quality must not drop to a level lower than that of normal series production. In addition, an attractive return on investment and the quickest possible time to market for new products and product variants must be ensured.

The key to this lies in establishing high levels of standardisation and automation which also provides scope for variations on customer-relevant product features. What’s more, the concept of modularization, which gives customers the opportunity to configure products on the basis of a modular system, is a cost-efficient way of satisfying individual customer requests in high quantities and with a high level of quality.

Customised mass production: a cost-efficient way of satisfying individual customer requests in high quantities and with a high level of quality

Industrial robot giant KUKA offers the “SmartFactory as a Service” concept. In Matrix Production, a concept developed by KUKA, intelligent automation solutions and a networked process chain pave the way for extremely versatile production processes on an industrial scale. Entire production systems and individual machines and robots can be converted ad hoc to accommodate different product types — without waiting times or production downtime. It will thus become possible to implement the manufacture of small-batch series, modules and individual parts in the context of industrial mass customization.

Smart Factory as a Service: scalable, fully automatic and adaptable production capacity can be booked as a service at a variable cost.

Case study: What is happening in the world of investment?

A double-edge sword: Active Investing vs. Passive Investing

There has been much debate over whether active or passive investing provides the best return on investment as both investing approaches are two contrasting strategies for putting your money to work in markets.

Passive investment management mimics an index of market returns, and does not require a manager to buy and sell at will. This investment method is lower cost and lower risk than active management, and seeks to minimise costs by limiting the number of trades performed. Research shows that in the long-run, passive investments are likely to outperform active investments due to lower costs, fewer timing errors and less likelihood of poor investment choices.

On the other hand, Active investment management aims to outperform the market index by stock picking; active managers analyse the market to identify investments that are undervalued, while selling investments that become overvalued. Typically, fees and risk are much higher with active management, as an investment manager must continuously analyse and trade securities, with each trade incurring its own cost. We can invest using either do-it-yourself stock trading or outsource it to professionals through actively managed mutual funds, active exchange-traded funds (active ETFs) or hedge funds etc.

For passive investment, portfolios are built around a core of ultra-low-cost index tracker funds. EBI focuses on minimising all the costs of trading and timing errors, including avoiding the cost of underperformance by active managers. Active investing, however, typically, costs are higher as you’re paying a manager to pick stocks, furthermore, managers will look to buy and sell securities in an attempt to beat the market, with each trade incurring a cost. We can invest passively by purchasing shares of index funds or ETFs that aim to duplicate the major market indexes like the S&P500 or Nasdaq Composite. Or we can have a robo-advisor do it for us.

Until recently, two strategies have kept their own territories like airlines’ first/business/economy class seat classifications simply because of the difference of its costs and level of customisation. Today’s retail investment environment, however, is challenging from almost any perspective because of price pressure from discounters, market disruption from online players, and increased price transparency for shoppers.Traditional differentiation approaches in investing — such as active investing with high performance/cost and high level of customisation vs. passive investing with low performance/cost and high level of tracking of benchmark indexes — are not as effective as they once were, as competitors can easily imitate them. Thus, two opposite investing approaches are pursuing different strategies to accommodate the opponent’s advantages. In other words, the active investing side is seeking low cost models, and the passive investing side is looking for more customisation opportunities.

Towards south: Active investing with lower cost

Mutual funds gained their popularity during the 1990s. They had existed before but were far from mainstream. The popularity was attributed to three factors: easy to buy, easy to monitor, and easy to own. Provided by a wealth of funds, the only thing investors have to do is just pick and buy the shares of the funds they want. Thanks to databases such as Morningstar and investment magazines, investors can track their performances and compare with others. Professional managers take care of funds portfolios, so investors are hassle-free.

Until recently, the resources for customised investing have been limited. The most popular service has been separately managed accounts. SMAs hold portfolios that resemble a (relatively concentrated) fund, but possess the securities directly. Consequently, unlike fund shareholders, SMA investors can modify their positions to create portfolios that are solely theirs.

The SMA industry has been moderately successful. According to a report from the research organisation Cerulli, SMAs are worth $1.5 trillion in aggregate. That makes SMAs larger than a cottage industry. Nonetheless, they have not offered serious competition for funds, which entered 2021 with $23.7 trillion in assets. To support the latter point, although exchange-traded funds were created after SMAs, ETFs have 4.5 times as many assets. Buses remain more popular than private coaches.

Part of the reason is cost. For those who hire financial advisors, investing with SMAs can be cheaper than owning active mutual funds. But doing so is not cheaper than using advisors to buy ETFs or index mutual funds. And for investors who make their own decisions, SMAs are clearly the pricier choice. For example, the annual fee for Charles Schwab’s Managed Account Select program starts at 1% for equity portfolios. The company does offer volume discounts for larger customers, but that program can never approach the price of Schwab’s ETFs.

Another reason that SMAs will not catch funds is that they occupy the wrong side of history. Traditionally, SMAs have been offered by active portfolio managers. The pitch has been: 1) Enjoy the benefits of professional management while 2) maintaining control of your portfolio. The latter promise remains attractive, but in this day of indexing, hiring active managers has become distinctly unfashionable.

Towards north: Passive investing through Customisation

These days, two additional strategies for customising investments have emerged. Each corrects the key objections to SMAs by slashing costs and eliminating active management. However, the two approaches are otherwise starkly dissimilar.

One has been widely discussed: do-it-yourself stock trading. Per The Economist, the number of retail brokerage accounts in the United States has ballooned to 95 million from 59 million over the past two years, for an increase of 61%. Retail trading activity has followed suit. Over that same period, the percentage of U.S. equity trading volume created by retail investors has grown to 40% from 25%. After gradually conceding ground to professional managers for the past several decades, retail traders have suddenly reasserted themselves.

It is customary to credit commission-free trades and the longer-term bull market for sparking the retail-trading fire. Those explanations are correct, as far as they go. But one must also credit the sense of fun. Target-date funds in 401(k) plans are fine investments, but quite dull. To differentiate themselves, brokerage firms increasingly sell excitement. For today’s smartphone entertainment, play an online game, place an NFL wager, or use your brokerage app to buy a stock.

The other customization strategy — direct indexing — is less widely known, although it has been highly touted within the financial-services industry. Effectively, direct indexing is the passively managed version of SMAs. Rather than hire an active manager, direct indexing investors begin with a passively constructed portfolio, then customise. They may harvest capital losses to offset capital gains; adjust their positions to compensate for the risk of owning a big slug of company stock; and/or apply investment screens, such as environmental, social, and governance criteria. Typically, such portfolios are more diversified than those offered by SMAs — and less costly.

As with baby names, direct indexing began with the very wealthy, but it has been moving down the economic ladder. Early versions of direct indexing required large outlays — for example, $5 million. However, thanks to technological and operational improvements, including the development of fractional shares, the cost of establishing positions in several hundred stocks has plummeted, as have investment minimums, which tend to range from $250,000 to $500,000.

Part III



investor, entrepreneur, reader, football fan (sometimes)

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