Scalable Capital is one of the flagships of the Munich fintech scene. The startup has been on the market for just two years and manages more than €600 million in client assets—and the number is growing rapidly. We spoke with Erik Podzuweit, co-founder and managing director of Scalable Capital, about investing, his company, and the value of cryptocurrencies.
It may sound premature to call a four-year-old company a success story, but there is much to support this: Based on the financing round completed in summer 2017, the company was mentioned in media reports estimated at 150 million eurosScalable Capital itself hasn't commented on the reports. At the time, the startup managed less than half of its current client assets. With company valuation as a measure of a startup's success—which is not entirely unusual—we are undoubtedly dealing with a success story.
Scalable Capital currently offers its services in Germany, Great Britain, Austria, and Switzerland. Another European country may follow this year. Collaborations exist with Siemens Private Finance and the direct bank ING-DiBa. In December 2017, the company already managed €600 million, and adds two to four million a day. Even with a conservative estimate, the billion-euro mark should be broken in the first half of 2018. But why do private individuals entrust their money to a startup? The minimum investment is €10,000, after all.
Scalable Capital invests its clients' assets in passively managed index funds, known as ETFs. These replicate the performance of stock indices such as the DAX as closely as possible: When market prices rise, the corresponding indices also rise; when prices fall, the ETFs also lose value. The company takes 0.75 percent of the investment assets annually for this purpose. The client selects the risk category based on a suitability assessment, but the investment decisions are made by an algorithm—the so-called robo-advisor.
The alternative to such asset management based on passive index funds, whose composition is adjusted over time by an algorithm, are active funds. Experienced fund managers attempt to generate a better return than the market through skillful buying and selling of securities and charge a fee for doing so. Advocates of ETFs and robo-advisors, however, argue that human investment managers, on average, do not outperform the market and that the fees only come at the expense of returns. Erik Podzuweit naturally supports passive index funds and the technology-driven approach. We asked the co-founder and managing director:
Let's get straight to the point: Why should I give my money to Scalable Capital and not invest in ETFs myself?
First of all, congratulations to everyone who knows what ETFs are: namely, the most cost-effective way to invest broadly in the capital market. Anyone who has recognized this already belongs to the most informed 10-15 percent of private investors. If you have the time, it's a good idea to invest your money smartly in ETFs. It's the most cost-effective way to manage your own investments.
One of the two main arguments for Scalable Capital and other robo-advisors is that we relieve investors of the product selection process. Investing in ETFs isn't as easy as you might imagine: There are approximately 2,000 ETFs available in Europe. A few dozen new ones are added every week, and the market is constantly changing. ETFs differ based on various criteria, such as costs, structure, and tax considerations.
Emotions influence private investments
A second component is the investment strategy. Traditionally, private investors are recommended to follow a buy-and-hold strategy: that is, buying ETFs and holding them for 20 years. This is subject to fluctuations. For example, the DAX often collapses—by 75 percent during the dot-com bubble in 2000, and by half again in 2008—but eventually it recovers. The problem is: many private investors, and even professionals, can't endure this. Once the index collapses, they might still be able to withstand the initial losses. At some point, however, people become emotional and panic. They then get out and realize their losses. Even worse, what often happens is that they stay on the sidelines and don't get back in. In our opinion, it's therefore advisable for most people to de-emotionalize their investments and hand them over to a wealth manager—not an investment advisor who wants to sell products. With us, the investment is done by a software program. This means that not even our own emotions play a role. We also tailor portfolios for investors to precisely match their risk preferences. We repeatedly observe private investors independently compiling ETF portfolios with much higher risk than they realize because they lack the tools to accurately measure risk. They also diversify based on gut feeling, often creating suboptimal portfolios.
A third reason for choosing robo-advisors is quite different: 20 percent of our clients are bankers. This may sound paradoxical, but many of them don't want to spend their free time dealing with financial matters, or they have to surrender their private investments due to compliance requirements. With us, they can move money in and out and choose their risk category, but they don't have a say in the choice of ETFs. That's why we're well-suited for people in the financial industry, consultants, auditors, bankers, and the like.
“It’s simply no use reading the newspaper and then guessing how the markets will develop.”
And why shouldn't financial professionals simply go to an investment advisor?
The term "advisor" is misleading, because the investment advisor's clear goal is to sell funds. That sounds like a stereotypical argument, but I've experienced it myself.
In addition, investment advisor fees are relatively high: An actively managed fund costs around 1.5 to 2 percent per year on an ongoing basis. In addition, there are custody fees, expenses, and trading costs. A total of around 2 to 3 percent per year is typical. At 0.75 percent plus ETF fees of currently around 0.25 percent, we are significantly lower. It's fair to say that most robo-investors are 50 to 70 percent cheaper than traditional investment advice.
Another argument is the investment methodology: Traditionally, traditionally managed funds with the corresponding storytelling were common: "I'm the expert in Asia and I travel to Hong Kong three times a year." That sounds reasonable. But the curious thing about the financial world is that the portfolio managers who read up on the information and make an investment decision are, on average, no better than an investment in the corresponding market index—which is usually significantly more cost-effective. It's simply pointless to read the newspaper and then guess how the markets will develop. The markets are too efficient at pricing new information.
Instead, we rely on an algorithm that can evaluate the data that really matters – namely, data on market risk – much more efficiently than any human bank advisor. Of course, we're not alone in this. Large institutional investors have been doing it this way for 15-20 years. Our algorithm isn't a philosopher's stone or a crystal ball for predicting price surges – those don't exist. Essentially, we use modern technology to implement what we know from recent financial science about the behavior of capital markets and time series: namely, that risk, unlike returns, can be meaningfully modeled and predicted. Our innovation lies in the fact that we now also offer such a robo-investment platform to private investors. They can become our customers within 20 minutes via their smartphone and don't have to worry about anything else.
“In the financial industry, it is already fashionable to have a professor or at least a guy with white hair”
You are three former Goldman Sachs bankers and a statistics professor. How did you come to found Scalable Capital?
Florian, Adam, and I worked together in a team at Goldman. They were both traders in London, and I worked on the client side of banks and asset managers in Frankfurt. For a long time, I was what I would call a "wantapreneur": You sit together in the evening over a beer and think things through, and you have great ideas. But as long as you don't quit, nothing will come of it. In 2013, I joined Westwing, which was my first step into the internet business. In the summer of 2014, we decided to start our own company and quit our jobs. I already knew Stefan Mittnik from Kiel before he moved to LMU Munich. I studied with him at the time.
When I approached him about collaborating, he immediately agreed. He was also the main reason we founded the company in Munich. He introduced us to former and current doctoral students as employees. The connection to LMU and the proximity to TUM are great. That's been a huge benefit to us. In retrospect, it was a huge coincidence: If I hadn't known him, I would have had to meet him.
In 2015, we built the company, applied for and received BaFin approval, raised venture capital, hired employees, the whole process. At the beginning of 2016, we launched our customer business.
Now let’s be honest: Is Professor Mittnik really operationally involved in the company or is he more of a figurehead?
In the financial industry, it's quite fashionable to have a professor, or at least a guy with white hair, on hand to convey seriousness. Stefan Mittnik, however, is actually fully committed to our team. He's the founder, has a substantial share of the company's equity, having invested in the company with private venture capital, and he developed the algorithm. We're located on Prinzregentenstraße, maybe a five-minute bike ride from the university. He's on our scientific advisory board, heavily involved, and attends many client events. We recruited almost all of our colleagues in the Financial Engineering team through his network.
“Allet jut” in Munich
If you ended up in Munich by chance, how satisfied are you with the location today?
Although I was born and live in Berlin, we are very happy in Munich. There are more trained computer scientists here than in Berlin, for example. This tech aspect is extremely important for a fintech company. Also, the people are less volatile—the turnover is lower, I think.
Furthermore, we have the full support of regulators, the administration, and politicians. As a fully regulated company, we are supervised by the Bundesbank and BaFin. The Bundesbank is decentralized and has its own presence in each federal state. The branch in Munich is very pragmatic and helpful. If you can't reach someone, they'll call you back on your cell phone. They want fintechs to settle in Bavaria. The administration here also functions very well: If we need a Blue Card for employees from abroad, i.e., a work permit for highly qualified jobs, it's done quickly and smoothly!
The political support has also been tremendous: Right at the beginning, we were invited to the Bavarian Finance Summit by Economics Minister Ilse Aigner. There, we met Siemens, with whose subsidiary Siemens Private Finance we later entered into a cooperation. ING-DiBa, with whom we now have a partnership, was also at the table. We maintain a very active exchange with the Ministry of Economic Affairs.
And one more thing: We're in the asset management business. And although we do target a somewhat broader audience, wealthy clients are very interesting to us. Munich and the surrounding region are a great location in this regard, too.
And where is there still room for improvement?
The infrastructure here still needs to grow. Right at the beginning, we were in Werk1, which was cool. But we outgrew it very quickly. After that, we wanted to rent an office in a central location. The landlords wanted to see our annual reports for the past two years. But we'd only been there for two months. When asked how we were going to pay the rent, we said we were getting venture capital. That already raised a few eyebrows. In short: Munich still lacks experience in dealing with startups in many respects. Perhaps Munich should consider creating a proper hub with only startups. In Prenzlauer Berg in Berlin, there's one startup next to the next, in Munich it's more spread out. But otherwise, everything's fine!
Branch banks and the Innovator's Dilemma
What's behind the cooperation with ING-DiBa? What do they need you for?
ING-DiBa is the third-largest bank in Germany by number of customers after Deutsche Bank and Commerzbank, but it has no branches and doesn't offer investment advice or asset management itself. They wanted to build an online asset management service and thought they could be faster and better if they found the best partner in Europe. We won a Europe-wide tender.
So it was their advantage that they couldn't cannibalize themselves with online wealth management?
Exactly. The other large banks aren't too stupid to build robos, of course. The problem is internal cannibalization. They have thousands of branches and advisors, and often they also have their own actively managed and therefore usually high-margin funds. Now you come along with a service that's cheaper and supposedly better than branch consulting. However, they would have to switch from their investment funds, which earn them 2 percent, to ETFs, which only earn half a percent or even less. Then the board member responsible for branch business would jump on your roof. That's a huge problem, Innovator's Dilemma: The banks see what's happening, but simply can't do anything else. ING-DiBa didn't have this conflict.
ICOs: “90 to 95 percent are complete rip-offs”
What is your vision for Scalable Capital — where do you want it to go?
We want the Becoming an ETF concierge in Europe: You hear or read about ETFs, don't want to get involved with them yourself, or know you don't know enough about the subject matter, and then you immediately think of Scalable Capital. We have a good chance of making this happen.
And now the inevitable question for a financial expert: What do you think about cryptocurrencies and ICOs?
This is a topic of conversation for me almost every day: in the office, with investors, while driving a taxi. I have friends who don't know the difference between a stock and a bond, and don't know what an ETF is, yet they invest their money in crypto. And I also consider the fundamental technology of blockchain—a trustworthy system without a central authority—to be visionary. The idea has real power and will prevail. However, the use cases are only just being tested. If you live in Venezuela, for example, you would probably rather invest your money in crypto than take it to exchanges. However, I don't believe in the utopian vision that cryptocurrencies will one day replace the dollar. And for investors in Europe, they are definitely not an alternative to a globally diversified capital market portfolio, such as one would use for retirement planning.
I'm extremely skeptical about the ICO boom. Sure, there are worthwhile projects, but 90 to 95 percent are complete rip-offs. These aren't equity investments in companies like venture capital. These are rights to use a business or software in the future, for which not a single line of code has been written yet. Some of these are teams that would never receive venture capital and deliberately pretend in their white papers that they are issuing equity investments in their companies. This ICO market will blow up in our faces. Then we'll see which projects have substance. In summary: There will be long-term use cases for crypto, even if the "right" valuation is difficult to estimate. I'm a total fan of blockchain; stay away from ICOs!
Thank you very much for the interview!
