The Big Interview: James McManus, Nutmeg

by , 9th October 2018

One of the most important factors behind the rising interest being paid to ETFs in the European fund management space comes courtesy of the rise of the robo-advisers. These tech-driven disrupters have made their mark, particularly in the UK where their consumer-friendly propositions have been drawing impressively building their assets under management. Among the leading robo-advisers in the UK is Nutmeg which has recently broken through the 60,000 clients barrier and now manages over £1.5bn in client assets. ETF Stream spoke recently to James McManus, investment manager and head of ETF research, to ask him about what comes next for the robo-sector and how he sees the future of his business and that of the underlying ETF sector dovetailing in the years ahead. We started, though, by discussing what Nutmeg’s attitude was to the recent headlines in the financial press about ETFs and the next crash and what he thinks will happen if the markets do turn south in the near future.

ETF Stream: Nutmeg has chosen to actively base its proposition around ETFs, yet ETFs have come under increased scrutiny in the financial press of late. How do you as a company address the criticisms around ETFs at present?

James McManus: My initial response is that scrutiny is a good thing. History has taught us that products or markets that grow quickly need scrutiny, and we should be willing to look at it and ensure the platform is there to allow it to grow. Being self-reflective and ironing out any issues in the marketplace before they become too big is not a bad place to be. History also tells us that typically it is not the things you are looking at in detail and are ensuring are well-structured that come back to bite you in a crisis.

That is a reasonable response – but what about Nutmeg’s customers? Is there a stress-testing capability within Nutmeg where you have looked at how you think most customers have behaved? Or is it rather that you have such a wide variation in customers that there is effectively no one answer?

Yes, potentially. We have been around a bit longer than we are given credit for! We have been actively running money for clients now for six years and in that time we have had some volatile periods. Particularly 2015, when we had over a 16% drawdown in the FTSE 100, but also the Greek debt issues, the Scottish independence referendum in 2014, China issues in the summer of 2015, the Brexit referendum, and a period of volatility earlier this year. Because we have the data we can actually tell you what our clients have done in these periods. If you look at the data between September 2012 and March 2018 in the five periods when there has been significant volatility in the UK equity markets, 96.7 percent of our investors didn’t do anything. They didn’t change their risk levels or withdraw funds. Interestingly, 2% did change their portfolio risk levels but more chose to increase the risk rather than decrease, and around 0.4% did withdraw their capital in those volatile periods

You must be encouraged by that data?

Yes, especially because the principle of our investment proposition is to get people to think about investments in a long-term way. When somebody sets up an investment with Nutmeg they are asked to anchor their investment to a goal, and to name that goal, for example whether it is their child’s education or buying a house. We want them to focus on that goal and getting there in the long-term. One of the interesting things we can do as a business is to use data to understand our clients and understand how we can help them make better decisions. So, when we have volatile markets, what is the information we need to put in front of clients? Which are the clients that need it most? What is their behaviour showing? We have five data scientists working in our office in London and that is their job. How many times has a client logged in? Are they exhibiting behaviours that suggest they might withdraw ahead of reaching their goal? The key focus is about the client’s outcome. Nobody wins if a client withdraws in a volatile market. They get out at a loss and we lose the client. We see our business as a partnership with clients and we want everyone to have a good outcome.

How do you think the general investment attitudes of Nutmeg’s customer base is evolving? Do you think there is more awareness now of the underlying ETFs involved in the investments compared to the early days of Nutmeg?

When it comes to defining who is a Nutmeg client there is no typical client It might surprise you, but the average age of our clients is mid-40s; these are not the Millennials the industry sometimes expects. One really interesting statistic is that around 40% of our clients have never invested in anything before – this will be the first time they invest. So we use data to be intuitive about what we put in front of clients. The inexperienced customers need a different type of content and handholding. We are very proactive about putting content out in front of clients, blogs and videos. Plus, we have a London-based support team that is available to on the phone, email or chat.

What are the assumptions about what those novice investors are hearing in terms of financial news?

We work on the assumption that they are seeing the same headlines everyone else sees, on the BBC or ITV, or newspapers. For us it is about making sure that no matter what type of client you are, experienced or inexperienced, that you feel like you are progressing your financial goals in a way that makes sense to you. Hopefully we are providing an intuitive understanding of investing to people. If you want to take a level of risk, to get towards a goal, you might need a longer timeframe. Getting people to understand the dynamics of decision-making when it comes to setting up an investment portfolio. They don’t need to understand the dynamics and intricacies of managing that portfolio – we offer that professionally managed solution – but we want to build an understanding of the dynamics of time horizon, risk and volatility.

So within that, to what degree does Nutmeg feel it has to educate around ETFs as a product or as a technology? Is that still necessary or is there an increasing understanding of that before people come to Nutmeg?

Again, there is no typical case. We feel it is incumbent upon us to educate our clients. A big part of our business ethos has always been transparency. To help clients along their investment journey. To help them understand what is in their portfolios and how we came to our decisions about what is in those portfolios. Our mobile app goes into great detail about each underlying ETF security. They can drill down to an individual holding level. They can understand the attributes that strategy has. They can see a comment from the investment team about why we hold it and the purpose of the strategy from an index perspective. To some extent if you want hands off you can but if you want the detail it is there for you. We do that with our blog and video content as well.

Let’s get on to the Nutmeg ETF selection process. What is your process currently – how many providers do you use?

We are entirely open architecture. We will consider any provider. We don’t have any biases. We only currently invest in fully replicated ETFs, we don’t invest in derivative-based or synthetic-based ETFs. That’s a reflection of who our clients are, what we believe they would like to see in their portfolios, and what we think it is reasonable for them to understand in terms of how an investment product works.

Are synthetics something you would consider in the future?

Not at the present time. Is it reasonable to expect someone like my mother to understand how a portfolio of equities could be invested? Probably. But is it reasonable for her to understand a multi-counterparty swap structure? That’s a different premise.

It doesn’t cut down on the variety of products you can offer?

No, not at all and there are very few markets where I would consider synthetic products have any advantage over fully replicated.

What about the developing attitudes of providers? Presumably that has changed over the years as robo-advice has become more established?

Yes, at the start we clearly had less assets, but, we have always found the ETF providers tremendously supportive. They have always been willing to list products we have required, and proactively ask for our feedback on product development. We are interesting to them because the European retail market has always been a difficult nut to crack for ETF providers. Partly that is about infrastructure. A lot of the existing infrastructure, such as stockbroking platforms, doesn’t lend itself very well to ETFs. It has been a case of fitting ETFs in rather than creating a great user experience. I think given the inroads digital wealth managers have made in the retail market in the past five years, most ETF providers believe it makes sense to help sponsor this growth.

I suppose you are competitive as well as cooperative in that you are getting to the end customer instead of them?

I wouldn’t say competitive because we are all part of the same ecosystem. We are reliant on great ETF products to build our portfolios, and in return the providers benefit from our growth. I think from their perspective if they see businesses that are growing and attractive demographics they might not have attracted before, that is quite interesting. This isn’t just targeting the same old clients – this is a potentially new client base that might never have come across ETFs before. It’s a symbiotic relationship whereby both can benefit

Is there more of a job they can do in terms of education?

Yes, the industry collectively has an obligation to make some areas of the market place less opaque. If you look at the media coverage of ETFs, the fact that some of the data is opaque and isn’t readily and easily accessible, feeds misunderstandings and a sense of suspicion. Collectively, if providers come together to solve some of these problems, such as a consolidated tape, everybody would benefit from it. On the education side, providers are already doing a lot. But how they get that content in front of people is an issue. If you go to YouTube and type in ‘what is an ETF’ you won’t see anything from the providers – it will be user-generated content. Increasingly, with a retail client base, they look in different channels to the ones the traditional providers expect. While a 30-page white paper is very interesting and very robust, getting analysis in front of people is the key challenge because they may not visit your website. You can look at parallels with different industries to see how that can be done.

What do you think the providers can do to further the progress being made by robo-advisers?

The first thing would be on the innovation front. Actually, the most important product standard we can have would be that only really excellent products, that fit really well in ETF structures are launched. There is the old adage that one bad apple spoils the bunch and I think increasingly there are a number of very innovative products that might not fit with an ETF wrapper over the long term and actually could present a risk to the entire ETF ecosystem from a reputation perspective. For example, I personally don’t think that crypto-based products fit within an ETF structure at the current time. Secondly, I would like to see more collaboration within the industry to ensure that some of the sticking points around trade data and operational infrastructure are resolved. It’s useful, if the ecosystem is going to grow, that the right data is available. It’s already in a very good place, but it can always be improved. We’re at a tipping point in the European ETF market right now and we have to question whether the fragmentation of the market place is a hinderance to long term growth

What about the apparent fee war. What is your official stance about lowering of costs? Presumably you are in favour?

Yes, but not at the expense of quality. We have no problem paying more for a product where we believe it is fundamentally a better product. We approach all our ETF selection on the basis of the total cost of ownership. That involves looking at details such as the size of the secondary market of a security versus the secondary market of another security where the primary costs are very high. We want to ensure that in total our overall value is higher in a given product than it is in another. If you want to put money to work in an asset where the primary market is quite costly, then one of the key benefits of the ETF structure is the secondary market liquidity. You need quite big products for that; so sometimes the product can be more expensive from a management fee perspective, but all in you are getting a lot more value and the clients are getting a better outcome because you are utilising the secondary market liquidity. Cheaper products attract higher inflows but it is not the be all and end all.

Do you see more smaller ETF provider entering the market?

It depends on what they are trying to develop and bring to market. For asset allocators such as ourselves ETFs are the perfect tools, and if someone wants to supplement that tool box that’s great. But if they are just producing the same tool with a different colour, that’s not so useful. I would be cautious about sponsoring further product innovation for innovations’ sake. For us, asset allocation comes first and I think there are some products out there now that, while I am sure are very attractive to sell, are very difficult for us to put into asset allocation portfolios because they don’t have the data history or they relate to a short-term or future trend.