Investing in fintech innovation

Technology’s disruption of financial services is still in its early stages, with developments in areas such as data analytics, cloud computing, and machine learning just beginning to transform the sector.

While industries such as e-commerce and music changed rapidly and produced only a few dominant players, we believe fintech—financial technology—will evolve differently, and with long-run implications for investors in financial services, information technology, and equity markets more broadly. Fintech’s greater complexity, regulatory influence, and geographical diversity drive our expectation that more, rather than fewer, leaders will emerge gradually over a longer time horizon. We estimate that global companies with a combined market capitalization of $8 trillion in the banking industry specifically and $16 trillion in financial services more generally are operating lines of business poised for disruption over the coming years.¹ In our view, fintech innovation and its potential disruption of the status quo present a vast, multidecade opportunity for investors.

We believe the most effective way to gain exposure to fintech’s secular growth story is by seeking companies that have financial technology at the core—not on the periphery—of their businesses. Our approach to investing in fintech as a theme focuses on companies in which at least 80% of revenues are driven by fintech sources, a large investable public market in and of itself. In fact, our team has identified a universe of approximately 150 companies that pass our percentage-of-revenue threshold.

The areas of the fintech market driving our interest include payments, investment and lending, and financial infrastructure. In payments, over 75% of global consumer spending remains cash based, leaving huge potential for further digitization.¹ Similarly, in investment and lending, roughly two billion adults worldwide don’t yet have access to a bank account, and digital transformation is just beginning to address the markets for capital and insurance.¹ Financial infrastructure offers the longest runway for growth, as most banks’ information technology systems were built in the 1980s and are ripe for improvement and upgrades. We’re also observing an inflection point as banks turn from defensive regulatory-driven spending to offensive investment in growth.

The complexity and depth of the fintech ecosystem demand a breadth of investor specializations. In pursuing fintech as an investment theme, we’ve brought together specialists—many of whom have experience dating from fintech’s inception—from payments, investment and lending, and financial infrastructure—and combined them with the broad research resources of our global financial and global technology teams. Together, these investors have thousands of financial and technology company meetings each year, developing proprietary research independent from that of Wall Street firms. We believe the key to success amid this disruption is deep collaboration to fully leverage the range of skills, expertise, and access to company management from multiple research teams.

In our view, as the fintech industry continues its disruption of traditional financial services business practices, the opportunity set requires both research experience and long-term company relationships cutting across industries, regions, and market capitalizations, including late-stage pre-IPO (initial public offering) and other private investments—many of which ultimately become public companies. Our ability to collaborate with our private markets colleagues provides critical insight into the durability of public market fintech companies.

“The complexity and depth of the fintech ecosystem demand a breadth of investor specializations.”

The enduring nature of the fintech story is, in our view, best served by an approach with a similarly long-term perspective. We think that the pace of disruption will be moderated, and the duration of disruption extended, by the inertia inherent in the financial services sector; relative to other industries, digitization in finance will probably take longer to play out because:

• Consumer behavior is harder to change
• The strength and value of incumbency are unlike those in other sectors
• Embedded financial infrastructure is critical in nature
• Regulatory oversight often results in more gradual changes

Instead of continually chasing the companies in the latest headlines and news reports, our team aims to identify the public market disrupters, enablers, and incumbents who we view as poised to succeed over the long term. Our approach to this secular theme seeks companies best positioned for the sector’s multidecade growth potential and, by extension, compounded returns over time.

In our view, the most effective way to gain exposure to fintech’s long-run growth story is by seeking companies that have financial technology at the core of their businesses. We believe fintech’s complexity further warrants an investment team with specialization stretching across the subsectors of financial services and technology—notably, with deep collaboration across research resources. Finally, as the evolution of this industry is likely to be gradual but enduring, we think the secular growth themes driving the fintech revolution merit a long-term approach.

1 Wellington Management, 2019.