Monday 5 December 2016 4:40 am

Risk and reward: Adam French, co-founder of Scalable Capital, left Goldman to develop an algorithm for matching retail investors with the right ETFs

For two years, Adam French knew he was leaving Goldman Sachs. “The day I quit was quite liberating – it’s just not that easy to step away from a Goldman job,” says the former trader, and chief executive and co-founder of digital investment management firm Scalable Capital. There was no “eureka moment”, he adds – rather “the transition out took about three months. It was all analysing the market, having chats with compliance consultants, researching what was already out there and what needed to be done to bring this to fruition.”

French set up the German arm of his business, which operates there and in the UK, in 2014. His co-founder in Germany, Florian Prucker, had been a colleague at Goldman. “We’d just spent two years upgrading all of the technology that we used within the trading desk to automate our jobs. We scaled from 1,000 trades a day to 10,000.”

The problem the pair had lay outside of work, however. “Friends and family kept asking what to do with their money. If you know someone working at Goldman, you assume they’ll know, but we didn’t. We felt like there was nowhere we could send people that was accessible (they’re normal people, not millionaires), low-cost and good.”

French and Prucker started building a solution they believed would change that – and bringing on more founders to help them do it. Here in the UK, where Scalable launched this year, French was joined by Dr Manuela Rabener and Simon Miller. “Simon actually has a similar background to me, having worked at Barclays. When we started out, it was him and me working in my kitchen.” Rabener, who heads up marketing, is ex-Mckinsey and a serial entrepreneur.

Relative to absolute risk

Scalable Capital aims to provide institutional-level investing to the retail investor. Like older firms in the space (whose coat tails French says Scalable is lucky to be riding on), it uses exchange-traded funds (ETFs) to invest across all major asset classes. And like others, it currently requires a £5,000 minimum investment, with an all-in fee of 0.75 per cent per annum. “The first wave of financial technology changed the packaging. But the technology underneath was still the old technology, the old business processes that the financial industry has used since the ‘80s.”

The Scalable team wanted to go beyond packaging and use technology to create a new product. “The traditional investment industry relies on ‘expertise’ and active management. We want to remove that. We know that technology can do so much better when it comes to money management than humans can because it’s unemotional, and millions of eventualities and processes can be simulated.”

Scalable has built an algorithm which aims to do just this: draw data and model a complex world without having to make simplifications or assumptions – and without layers of people and process, which add cost. The firm calculates that a £100,000 investment, with a 6 per cent return, would yield £12,716 more than a traditional investment manager. Over 30 years, that’s £93,523.

Rather than focus on building teams of operations or sales people, the bulk of Scalable’s 42-strong team are financial and software engineers. As an investor, rather than be put on a risk scale – a two for taking less risk, or a seven, say, if you’re willing to take more – Scalable uses a percentage scale to ascertain how much you’re willing to lose. So if you’re at 15 per cent, that’s the hit you’d be willing to take in a really bad year.

“We want to move away from relative risk to absolute risk. We run simulations on an individual portfolio basis, so even if you’re in the same risk category as someone else, your portfolios might look different. You might have joined on different days, so certain trades would have made sense for one person but not the other.” French is confident the business will continue to personalise its approach, with plans to factor in things like how much tax someone is paying.

Using ETFs helps with this, he says. “Unlike in Germany, where they’ve been sold by banks as financial instruments, these are still a relatively new product in the UK in terms of how people think about them. But, when it comes to assets under management, they’re larger than hedge funds, and bring the best of both worlds: diversified holdings and traded on stock exchanges. Using them means real-time pricing and daily liquidity. We can get out of an instrument whenever we want and, because they’re passive in nature, we’re not paying a manager.”

I ask why people can’t just go and buy ETFs themselves. French says the answer lies in convenience: “with 1,500 ETFs on the market in the UK alone, which should you invest in? That’s a problem 99.9 per cent of people don’t know how to solve. And even if you do make simplified assumptions and sit with a spreadsheet, that’s not what most people want to be doing.”

Robo? Oh no

Interestingly, while robo-advisers are often treated with a degree of scepticism in the UK press, says French, Germans have been more enthusiastic. “The landscape is very different there. There’s 1,600 banks versus our 400, and no independent financial adviser (IFA) market. If you wanted investment advice you’d go into a bank and ask about the product of the month. Combined with negative interest rates and people having to pay for the privilege of sitting on their cash, robo-advisers have been welcomed as a fantastic alternative to a less developed market driven by sales, rather than advice.”

Manuela Rabener and Simon Miller joined French as UK co-founders, where Scalable Capital launched this year (Source: Greg Sigston / City A.M.)

French admits he “hates the label robo-adviser. It’s something that’s come out of the US and been put on anyone doing something that’s online and investing. But the idea that we’re providing advice is completely wrong. It’s a moniker that exists because people don’t understand that there’s a fiduciary relationship out there that’s accessible – because they’ve never seen it before. ‘Robo’ always gets attached to new technology – traffic lights were originally called ‘robo-traffic wardens’. Hopefully we’re not far off this just being called investing!”

Next year, Scalable, which has raised around £10m to date, will go for more funding. While it’s deliberately focused on a fairly niche, mass-affluent market so far, it’ll press on with penetrating the UK market more widely, in addition to rolling out a Sipp (you can already open an Isa). French is also excited about B2B opportunities for the firm – i.e. selling their product to banks.

“We’ve started to have conversations with big firms. They all know they need to do something, and either they do it in-house or buy other firms’ products. They don’t have the expertise, so they’re turning to fintechs. And it’s difficult for them because they can’t cannibalise their own discretionary services by building an online tool that’s better. We’ve already got the systems in place for white labelling, and I think we’ll see the theme of collaboration more widely develop a lot in 2017.”

In the meantime, French has found himself on a cycle of coffees with banking friends and ex-colleagues. “While I was on gardening leave I was getting internal phone calls all the time wanting to know how I did it. It was the right time for me – I’m married but don’t have kids or a big mortgage. I made good money but saved it.” But the number of meetings has dwindled. “I was meeting someone once a week when we started out, but I’ve had fewer conversations recently – perhaps because I’m getting busier, perhaps because the market’s changing. A lot of people are tied to their job, but they really want to move out and start a technology-driven business."