RIA Spotlight:
WST Capital Management

Hollie Fagan, head of BlackRock’s Registered Investment Advisor (RIA) Business, interviewed Roger Scheffel, Chief Investment Officer of WST Capital Management (WSTCM), the quantitative research and capital management division of Virginia-based RIA, Wilbanks, Smith & Thomas (WST). Born a decade ago as a research group within WST and formally established as its own division in late 2015, WSTCM now manages approximately $500 million in assets.1

HOLLIE: Knowing how many of your peers are interested in ways to scale their business, can you tell us more about your thought process in choosing to formally create WSTCM?

ROGER: As WSTCM began to take shape as an investment boutique under its parent RIA, we saw that we needed to make a distinction between the objectives, service models, and resources of WSTCM versus the wealth management side of the house. While we believe we put clients first in all aspects, we serve them in different ways between business lines. We felt this change was the best way to continue to support that evolution while preserving the integrity of our existing business as a wealth management firm.

HOLLIE: You speak about WSTCM as an evolution, not a quick decision. What specific challenges did you face along the way that others in the industry should look out for?

ROGER: We encountered plenty of challenges common to new or emerging firms; namely, we had a limited track record when we first set out to market our strategies and grow our client base. Once we finally convinced that first partner to include us on their platform, we had to prepare ourselves to support sales efforts and a new base of advisors. “Growing pains” were inevitable despite the existence of a very seasoned back office and expert trading department. We have learned there is a world of difference between traditional wealth management and investment management in terms of compliance, marketing and client service requirements and practices. Getting it right takes time, internal training, technological investment and, occasionally, external help to get us literate on critical issues in this area of the business. For example, we have come to value WallachBeth Capital as an execution consultant and partner, and we are working with ACA Compliance Group to prepare ourselves for GIPS® verification, which has proved a big undertaking for WST. We see plenty of headlines about the consequences of getting it wrong or cutting corners in the effort to grow, so we have tried to move at a strategic pace.

HOLLIE: You mention leaning on the resources of your RIA parent firm, which was sizable and established even in the early days of WSTCM. What difference did that support make?

ROGER: We began with valuable intellectual property and developed naturally over a full decade under a well-resourced, stable parent firm that was willing to seed strategies and invest long-term in a high-conviction idea, even if payoff wasn’t guaranteed or it was far down the road. There was no P&L for many years, and no pressure to begin marketing strategies before we felt prepared to take on clients. Our firm as a whole was not going to fail if WSTCM didn’t materialize or take off. This approach worked for us, but other firms might consider shopping around the marketplace for an existing strategist or partner if this opportunity to scale isn’t occurring naturally or without great risk to the business overall.

...we’re proud of the fact that WSTCM developed out of the effort to better serve our wealth management clients.

HOLLIE: Now that we understand a bit the business history, we’d like to dig into your firm’s experience as innovators on the investment side. What’s something unique about WSTCM that you are particularly proud of?

ROGER: We took an early interest in rules-based and quantitative investing, beginning with early smart beta factor-weighting around 2004. Once convinced of these techniques, we looked for a solution that was appropriate for and accessible to clients like ours – mostly individuals. We couldn’t find the right solution, so we built one ourselves. Our first rules-based, risk-managed strategy launched in 2006, but it took a decade of internal investment and development for WSTCM to become its own division. We believe we’ve made a habit of innovation and early adoption and we’re proud of the fact that WSTCM developed out of the effort to better serve our wealth management clients.

We’re also very proud that, in 2010, we became the first RIA to launch a custom index in collaboration with S&P Dow Jones Indices. Initially, we undertook indexing as a way to externally validate the back-test for our U.S. Equity approach; we wanted an expert to check our work and vet our conclusions about how the model would have handled historical market environments and cycles. Obviously, we do not view or market the back-test as actual historical trading results, but it did increase confidence in our models and it laid the groundwork to develop our platform based on that same quantitative science. Since then, we have expanded and maintained that practice as a way to promote transparency for clients. This collaboration has grown to include several custom indices, and we have benefitted greatly from working with and learning from the S&P Dow Jones Indices team.

HOLLIE: Aside from providing exposure to specific market areas, what role do ETFs play in your approaches?

ROGER: ETFs don't simply enable our approaches by providing the exposures we want – ETFs support critical aspects of portfolio design and, overall, support our value proposition. For example, our risk-managed international equity strategy is based on the iShares Global Sectors and iShares Edge Minimum Volatility ETFs, which allow us to capture a tailored factor profile in the tactical opportunities we identify and pursue. These points are unique, structural considerations that we believe differentiate our approach from earlier-generation smart beta.

HOLLIE: Tell us more about how your models operate, what are the critical processes you have in place?

ROGER: We feel our approach combines the best of various disciplines – namely, joining the efficiencies of indexing with the benefits of risk-oriented active investing. Rather than tracking passive allocations across segments and sectors en–dash with most active approaches that are managed to a benchmark en-we use an objective, rules-based model to determine and shift allocations according to market cycles. Our approach is distinct from traditional active management in that our model-based process avoids the emotional and discretionary aspects on one hand, but on the other hand it mirrors the risk management piece of active management’s value proposition. We rely on the synergies between portfolio design and quantitative research to differentiate our strategies and position us somewhere in the middle of active and passive. As to how the models operate; essentially, we design rules, or parameters, within which the model can direct allocations based on what the market is signaling with regards to momentum and other factors. The model is written to consider factors we specify. Risk-management is multi-layered and begins with portfolio design at the outset – we identify guidelines, ranges of exposure for segments (or “buckets” of assets categorized by risk), we undertake security selection insofar as we research and define which ETFs to use, and we specify the mechanisms by which the model can address risk.

We constantly monitor the model, but we exercise essentially no discretion except at the point of portfolio design and rules definition. Essentially, we have designed our model to think adaptively like a portfolio manager, but according to a far more sophisticated statistical understanding than one generally finds in fundamentals-based portfolio management. The rules-based process removes the option to allocate or shift capital based on subjective assumptions or behavioral impulses, but thoughtful portfolio design and multi-layered risk management reflect authorship behind the science.

...we have greatly simplified, across all areas of liquid markets, the effort to join the two most important outcomes in investing: protection and growth.

HOLLIE: Clearly, you have put significant thought into portfolio design and execution. How do you articulate your value proposition to clients?

ROGER: The global economic landscape has taken shape such that markets are volatile and subject to large pullbacks at surprising frequency. We’ve seen that these uncertain, fragile-feeling markets can test the nerve of the most seasoned and sophisticated investor, and many investors either simply accept the give-and-take cycle as a fact of market participation, or they allow emotional, behavioral-driven impulses to determine investment decisions and compromise long-term outcomes. We feel that better outcomes can be achieved through adaptive models, multi-tiered risk-management and more cost-efficient, liquid exposures accomplished through the use of ETFs. One recent example would be our earlier-mentioned international equity strategy the day after the UK voted for so-called “Brexit”; given our risk-managed positioning and use of low-volatility ETFs, the strategy was spared a significant amount of sharp equity drawdown relative to its benchmark and other international equity indices.

Our approach is also scalable across various asset classes and multi-asset implementations. We leverage, across all strategies, the same risk-managed science to establish core asset class exposures that are responsive to the emergence of both opportunity and increased risk. We’ve seen that our approach is effective also in non-core or even niche implementations such as liquid alternatives and MLP portfolios. Ultimately, we would argue that through the combination of quantitative investment “science” and the structural strengths of ETFs, we have greatly simplified, across all areas of liquid markets, the effort to join the two most important outcomes in investing: protection and growth. We are not the first or the only firm to see the light with regards to actively managed ETF portfolios, but we do feel we’re differentiated and well-positioned to be a whole-portfolio partner to investors of all types, helping clients address their unique needs.

HOLLIE: You alluded to some of the forces changing our industry. Where do you feel we are headed and what do you feel our RIA readers should be thinking about?

The DOL fiduciary rule is going to change the way RIAs and related industry participants do business. There will be more documentation and scrutiny on the actions taken in client portfolios, and advisors’ decisions must be driven solely by client objectives and needs.

That said, nothing changes for us because we already operate under these tenants. We believe each of our strategies addresses a critical need in the marketplace and we have high conviction in our process. We know that our strategies are priced appropriately relative to our value proposition, and we are confident our approaches will hold up very well as these new standards are better understood. Ultimately, we hope that RIA and advisory partners who embrace our approach will see our offerings as a platform of “building blocks” for an integrated, whole-portfolio solution that can be implemented at lower cost to clients. As long as we stay disciplined and committed to delivering the best-possible results for our clients, we see industry evolution as a potential tailwind for solutions-providers like us.

Roger Scheffel
Chief Investment Officer for WST Capital Management
Hollie Fagan
Head of BlackRock's RIA Business