We currently see a number of specific developments that make fintech an interesting investment theme for next year.
Fintech is an excellent example of a secular growth theme that offers attractive opportunities for investors. And while we believe in the long-term attractiveness of this thematic investment, we also see several developments in the coming year that make fintech particularly interesting.
But first we feel it is important to emphasize that fintech has changed dramatically over the past few years. What basically began as back-end payment service has transformed into an industry in its own right, leading to the unbundling of financial services now and in the future. Fintech solutions have now also been developed for areas such as consumer credit, foreign currency transactions, insurance and wealth management. And the number of fintech companies has grown significantly in recent years, with over 2,500 deals being completed in 2017 compared to just 330 in 2010.
The many new developments in fintech continue to reshape the financial sector. Some of these use emerging technologies to enhance financial services (fintech), while others are aimed at improving existing capabilities within the financial services industry (techfin). Together they will shape the fintech universe going forward. Two examples are artificial intelligence (AI) and big data. Electronic payment services involve the real-time analysis of huge amounts of data, increasing the risk of fraud. Neither this analysis nor the prevention of payment fraud are possible without both AI and big data.
Another growth area is core system replacement. Many financial institutions still run software from the 1970s and 1980s, developed and expanded in isolation. Connecting these outdated systems is an arduous task and many can’t run new services and tools. Eventually they have to be replaced by more suitable, flexible systems offering opportunities for fintech-focused companies. The same goes for financial inclusion. In many countries, the economics of the traditional bank branch or insurance agency model do not work. Low density and relatively low GDP per capita mean it is not economically viable to open bank branches in rural areas. Basic financial services have to be provided by more electronically scalable solutions. Finally, the fact that payment services is the most mature part of fintech does not imply a lack of growth opportunities. The market share of digital payment solutions is still growing rapidly, a trend from which payment processors, networks and acquirers are benefitting.
We currently see a number of specific developments that make fintech an interesting investment theme for next year. First, the investable universe is still growing. There will be many new IPOs in 2019, including some major US companies. Robeco has already identified more than 200 listed companies that fit the fintech theme. Liquidity is not a constraint, which means there is an increasing number of opportunities for active investors to both differentiate and diversify.
Second, the solid outlook for financials implies that these companies will have more cash to spend on replacing of systems and technology in general. With GDP growth set to continue, many companies are raising their budgets for capital expenditures. This is a positive trend for so-called technology enablers, many of which operate within the fintech universe.
Third, we could see more splits in the technology sector. Currently, technology segments like e-commerce, social media and fintech are mentioned in the same breath, despite having very different dynamics. Not all tech should be treated equally. More distinction will create more visibility on the strong earnings growth fintech offers. Now that the world has digested buzzwords like AI, blockchain and Robo advisors, we also expect the focus on the actual business and the strong fundamentals it represents to increase.
Finally, as this year’s Outlook reflects, 2019 is expected to be a year of transition, at least for financial markets. As this transition is likely to be accompanied by more volatility, exchanges, market makers, trading platforms and so on look set to benefit. This is another example of the far-reaching impact that the rise of fintech is having on the financial markets.
Investing in a young, innovative and fast-growing sector like fintech is obviously not without risks. Many fintech companies can be defined as growth companies, which are more sensitive to rising interest rates. We also believe that regulation is a key area to watch in 2019. Many fintech solutions have been able to develop under a light-touch sandbox regime, which has boosted competition. But the big question remains: can these start-ups keep growing fast enough and become profitable enough to deal with increased regulatory scrutiny, like their traditional financial peers.