Scalable Capital: A financially viable robo-advisor?

Aug 17th, 2016 | By | Category: ETF and Index News

Last month, investment management company SCM Private released some damning research arguing that so-called “robo-advisors” were not financially viable. This has not deterred Scalable Capital, a digital investment management proposition which builds portfolios exclusively from ETFs, from entering the UK market.

Adam French, founder and managing director of Scalable Capital

Adam French, co-founder and managing director of Scalable Capital

While the firm’s AUM is not available, it has over 1,200 invested clients, with investment amounts often substantially above the minimum threshold of £10,000. The move into the UK marks a key step in the firm’s ambitions to expand throughout Europe, having already established operations in Germany and Austria.

Rebecca Hampson, associate editor at ETF Strategy, talks to Adam French, co-founder and managing director of Scalable Capital about why it has launched in the UK, why ETFs and whether being a robo-advisor is financially viable.

ETF Strategy: Why have you launched in the UK?
AF: We launched in the UK because we saw a need in the UK wealth management market for clients that want access to a smart investment strategy, and at low cost. We weren’t convinced that any of the existing online investment managers were offering more than just a nicer packaging around an old-school investment approach.

Unlike any other provider, we use a sophisticated, data-driven risk management technology to fundamentally change the way people can invest. Robo shouldn’t just mean cheaper. We want to provide a service which is both cheaper and better than traditional alternatives.

Although we have been live in Germany for over six months we always planned to launch in the UK from the start. The current investment propositions across the whole of Europe are poor and therefore we see a big opportunity to provide a cheaper and better service across borders.

ETF Strategy: Who is your target audience?
AF: We target three groups: mass-affluent smart professionals; HNWIs (high net worth individuals) who previously didn’t have access to the technology-driven investment methodology that we offer; and traditional advisers looking for opportunities to offer their clients an investment technology that fully exploits the benefits of data-driven investing.

ETF Strategy: How are you reaching out to them?
AF: We invite investors in the UK to meet us at roadshows and we regularly organise webinars. In addition to this, we rolled out an outdoor advertising campaign at Liverpool Street Station and will soon follow up with a large Tube campaign. We also regularly attend events, like the Retirement Money Show and other personal finance events. We have recently launched our blog “Insights”, which aims at providing information to investors on investment planning and strategy. Investors can also find us on Twitter, Facebook and LinkedIn, and we respond to chat or email within minutes or hours. Being robo doesn’t mean that we are not available for our clients to speak to – it might actually be even easier for many of them to engage in a conversation with us

ETF Strategy: Why ETFs?
AF: ETFs are an ideal investment vehicle as it is possible in a single transaction to invest in a whole region or asset class – they allow us to get a very broad diversification and, more importantly, are cost-efficient. We screen the whole ETF market for what we call the “best” ETFs. Focusing on a multitude of quantitative and qualitative factors we ensure that the ETFs in our clients’ portfolios are low-cost, highly liquid and replicate the indices they are supposed to with high accuracy. This helps to solve a big problem for investors: which ETFs to invest into out of the 1,500 or so available to them. It also means that when a better ETF comes to market that we include it in our screening process and automatically move our client assets into it in an efficient manner.

ETF Strategy: What’s your investment strategy?
AF: This is where we are fundamentally different to existing offerings. Our investment methodology is inspired by Robert Engle’s work on volatility clustering instead of relying on Modern Portfolio Theory, which is effectively a theory from the 1950s using several simplified assumptions that have become obsolete in a world where we can tackle data issues with modern technology. So, we use cloud-based simulations to project market risk based on current and recent market movements.

We measure each client portfolio’s value-at-risk (VaR) and re-balance portfolios daily if required. The result is what we label dynamic risk management. The investments we make on behalf of our clients are in line with their risk tolerance at all times and in all market conditions. If at any time our client’s portfolio threatens to exceed the loss risk he or she is willing to take, a risk-reducing portfolio reallocation is carried out automatically. The ultimate result for clients is simple: the risk in their portfolio is maintained at the level they set it at and fluctuates less with the risks on the financial markets. This is very important for making sure our clients feel comfortable with their investments in the market and allows them to stay in the market for longer. And it is very different from the “re-balancing” some other providers are offering, which typically means that a portfolio’s asset allocation is set back to its original allocation at static time intervals (for example once or twice a year).

ETF Strategy: What is currently in your portfolios?
AF: Responding to increasing market volatility ahead of the Brexit decision, our dynamic risk management approach had shifted our clients’ portfolios into a more conservative mix of investments already in recent months. This resulted in an equity allocation of our highest risk categories of less than 40%. In the middle-risk categories the equity allocation was less than 25%, decreasing further to below 8% in our most conservative risk categories. The higher than usual allocation towards both government and corporate bonds helped to stabilise the portfolios in times like this while keeping the need to keep client’s money in cash that would be exposed to a currency decline at an absolute minimum.

ETF Strategy: Do you use active ETFs?
AF: No. We invest in the various asset classes exclusively through passive ETFs. We do not believe that active management provides the best outcome for our clients and it would be hard to find data showing that active management adds value when looking at returns after fees.

ETF Strategy: How valuable is the trading aspect of ETFs in a portfolio?
AF: ETFs are traded on exchanges and are therefore highly liquid. This offers a high degree of transparency: on a daily basis, investors can see the securities held by the ETF, the performance of the ETF, as well as the costs incurred. This also means our investors can withdraw their money at any time. It is their money and we don’t want them to be tied into something when they do not want to be.

ETF Strategy: What are the costs?
AF: Our all-in fee of 0.75% p.a. includes investment management, account management, custodial charges and all trading costs. The total cost of the ETFs used currently average 0.25% p.a.

ETF Strategy: How many portfolios are there?
AF: We offer 23 different portfolios, with 23 different risk categories, ranging from 3% to 25%, associated with annual 95%-VaR limits. For example, an investor choosing risk category 12% wants to limit downside risk so that an annual decline of more than 12% should occur on average only once in 20 years. By using VaR as a risk metric for our portfolios instead of arbitrary terms like “medium” or “5 out of 10” we give our clients a better understanding of how much risk is in their portfolio in all market conditions. Again a fundamental difference to the traditional way of doing things, even with other online providers. We can only offer this level of transparency about risk to our clients because of our data-driven risk management technology.

ETF Strategy: Are they available to anyone?
AF: Through our online questionnaire, we determine the knowledge and experience, financial situation and investment objectives as well as the personal risk-appetite of the investor. Based on this information, we recommend a suitable investment strategy for them, or we tell them we cannot recommend a suitable investment strategy for them. They ultimately decide how much risk they want to take but we make sure that they do not take more risk than we determine to be suitable, in line with the regulatory guidelines.

ETF Strategy: Do you have any performance data from the portfolios?
AF: The first portfolios we offered in the UK were opened at the beginning of May. These were in the medium risk categories so between 15-20% VaR. As of last week, these portfolios showed a positive return of 14%.

The good news around Brexit was that all of our portfolios made money through that period. Even in our short life to date we are already seeing clients who have opened up with a £10k portfolio now transferring more of their investments to us because they are happy with our performance, they like the usability of the platform and they like our complete transparency.

ETF Strategy: If you consider yourself a robo-advisor, how does this fit with some saying that they are financially unviable?
AF: We would not be comfortable coming to market with a business model which cannot solve a real client need in a financially viable way. There is a huge need for a service like ours and our value proposition is unique, attracting both mass-affluent investors and HNWIs alike. What we have found so far is that the economics work well once clients start moving more of their assets to us and recommend us to friends, which is exactly what we’re observing already today. This means we are capturing market share from incumbents as well as reaching people who haven’t invested in the markets before, tapping into a large market opportunity. Based on the positive dynamics around lower-than-expected customer acquisition cost, we are investing further into our development across Europe. But even if we were an undifferentiated me-too provider struggling to attract assets, there wouldn’t be any risk for our clients, as we hold all client money at our custodian bank in segregated accounts. Clients would therefore not be financially impacted by a termination of our service in any way.

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