Scalable Capital uses technology to cut the costs and manage the risks of personal investing
In April this year, Scalable Capital completed a €7 million fund raising. It is quite an achievement for a business founded as recently as late 2014 but, as the name suggests, the founders are using technology to adapt business models and methodologies developed by major financial institutions for wealthy clients only.
By applying them to retail investors, Scalable has the potential to live up to its name in another sense – by becoming extremely large. They are not alone in believing this. The latest funding builds on a €1 million angel investment completed in early 2015, and an injection of further funds by the German venture capital firm, Holtzbrinck Ventures, which took the total seed funding to €4 million.
"A large part of the appeal for our investors was the team," says Simon Miller, co-founder of the business in the United Kingdom. "They valued the core skills each member brought." Miller, who joined Scalable from the Barclays investment bank in 2015, has chosen to bet his future on four Goldman Sachs alumni - Erik Podzuweit, Florian Prucker, Patrick Poeschl and Adam French - plus Stefan Mittnik, a financial econometrics professor at Ludwig Maximilian University in Munich.
"While they were at Goldman, friends and family were constantly asking them about how to invest their money," explains Miller. "There was no good answer for anyone with less than millions of pounds to invest. They saw an opportunity to provide a better investment experience. They also wanted it to be simple, accessible and transparent."
In line with their original ambition to make their service more broadly accessible, Scalable has set its minimum portfolio size as low as £10,000, but the typical client so far for Scalable is a 45-year- old, digital savvy professional with experience of investing. That experience does not have to be negative, though that helps. "We want clients who appreciate the way we control risk, contain the costs and target better returns," says Miller.
The foundation of that superior solution is to maximise the use of technology, from internal business processes through to the delivery of the service to customers. Operating an online business lowers client acquisition costs. "With our cost base controlled by the use of technology, we can service 10,000 clients with £30,000 rather than 50 clients with £500,000," says Miller.
The company also dispenses with the fees charged by expensive analysts and fund managers. "We select the cheapest and most liquid products, in the form of exchange-traded funds (ETFs)," explains Miller. "Our investment universe is made up of 14 ETFs, which offer our investors access to over 8,000 securities in more than 90 countries." A fixed management fee of 0.75 per cent covers management, custody and trading costs. The average ETF cost, which is built into ETF structures, adds another 0.25 per cent on average.
This low cost structure and use of ETFs does not preclude individualisation of investment portfolios. The computing power now available at low cost makes it affordable to create bespoke portfolios for the needs of individual clients. Investors access the Scalable service via the web site, where they complete a familiar form whose content is designed to tease out their attitude to risk, their goals, their timeline and their experience, whilst also satisfying the suitability tests set by the regulator.
"We then show potential investors on-line the portfolio that suits their profile, and how it might perform over the next five to 30 years," explains Miller. "They can also play around with different levels of risk, to see the impact on value and performance, using our on-line tools." Once they have signed up, investors have access, among other things, to a view of their current portfolio weightings, any changes to their portfolio, and the charges they are paying - and in real-time too.
Scalable attaches particular importance to its management of risk, because it delivers a smoother performance over time and aims to ensure that each unit of risk delivers the optimal return. "Rather than selecting a medium, low or high level of risk, we ask clients to choose a percentage level of risk," explains Miller. "If they choose a 10 per cent level of risk, for example, we are saying that there is a 95 per cent probability they will not lose more than 10 per cent of the value of their portfolio in the next 12 months."
The investment model creates the portfolio in line with the percentage level of risk chosen by the investor. On a daily basis thereafter, the investment model re-calculates the risk based on current market data, and uses Monte Carlo simulations to project how market changes are affecting the risk in the portfolio. "It might show, for example, that the risk has risen from 10 per cent to 15 per cent, and so we make a risk-reducing adjustment designed to ensure the investor retains the optimal level of return for the level of risk they are comfortable with," says Miller.
The adjustments are made automatically, in the sense that the customer does not have to sign off on them, but Scalable retains internal checks and controls to ensure that the model is delivering the agreed outcome for the client. The trading costs of making the changes are incorporated in the 0.75 per cent annual management charge. The bid-offer spread - typically, 0.05 per cent in an ETF - is factored into the risk model before adjustments are made. "We would not make the adjustment if the cost of making the adjustment meant the change did not make sense," says Miller.
He is confident that Scalable is not exposing clients to the peculiarities of the ETF market. He points out that the ETFs chosen by the firm are selected on the basis of cost, liquidity and tracking errors, so they are all well-established, with a proven record of adhering to their advertised objectives. "In the passive versus active debate, we strongly believe in passive instruments," says Miller. "There is a strong body of evidence that most active managers do not consistently outperform their chosen benchmarks."
Three of the five founders are German, so it made sense to apply simultaneously to the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Bonn as well as the Financial Conduct Authority (FCA) in London for licences. Somewhat surprisingly, the BaFin authorisation came through earlier (in July 2015) than the FCA (in February 2016). As a result, Scalable is live in Germany already, where it is now adding €1-2 million a week in assets under management, largely through online marketing channels such as social media and Google, but also via small-scale outdoor campaigns.
"An encouraging amount of the growth is coming from existing investors who initially gave us a test amount, and are now coming back with larger amounts, having had good results," says Miller. The firm also signed a partnership with KSW, a German wealth manager, in April 2016. "KSW see Scalable as a way to engage their more digitally minded clients, as well as attracting younger investors with smaller amounts to invest than their traditional clients" adds Miller.
Late April will also see Scalable launch in the United Kingdom. A waiting list of clients is already drawn up, and they will be the first to be invited to join the service. The launch will be accompanied by an intensified marketing campaign, including an investment blog (https://uk.scalable.capital/insights/) and possibly campaigns on the London Underground and outdoors. In the United Kingdom, Scalable expects its sophisticated investment model to appeal to IFAs looking for a low cost and effective wealth management solution for their clients as well.
Once the United Kingdom is up and running, Scalable intends to expand further in German-speaking Europe, starting with Austria and potentially moving on to Switzerland. "One reason to start simultaneously in Germany and the United Kingdom was to internationalise the business from the start, so we could pick it up quickly once we were established in our first two markets," says Miller. "Our goal is to build a pan-European business."