Which three trends are drastically changing the financial sector? Interview with Robeco portfolio manager Patrick Lemmens.
The financial sector is changing radically. Aside from the legislative and regulatory burden, there are three trends affecting companies. According to Patrick Lemmens – portfolio manager for Robeco New World Financials Equities – these are digitalization of payments, the burgeoning middle class worldwide, and financing aging.
Lemmens selects companies for the fund that anticipate these three trends. Diversification is key here.
Digital Finance is the transition from cash to credit cards and electronic payment. According to Lemmens, new players are entering the market who are better able to run payment transactions for stores and webshops than the traditional banks. Examples include Adyen, supplier of payment systems for stores and web shops. However, Lemmens is unable to invest in Adyen, as it is not a listed company.
“Such companies represent increasing competition for traditional banks. They use smarter technology than banks and a different credit-confirmation system to reduce default risk. One example is the payment risk arising when you do not receive goods purchased from a web shop and then demand your money back. This is when the financial services provider is exposed to payment risk on the transaction. Banks want to limit this risk with more legal and administrative red tape. This makes their payment-traffic solutions even slower to accept new clients,” said Lemmens.
Mobile payments are the fastest-growing segment within Digital Finance. Lemmens emphasized that various different companies could benefit from this. “These companies constitute a very diverse group. Some work with the seller, others target only payment settlement, or focus on selling technology or providing advisory services to banks.”
The big question at the moment is: what is the best system for electronic payment traffic? We're still a long way from an industry standard, said Lemmens. “We will first enter a situation involving multiple standards that will exist side by side for a time. Eventually, only a few systems will remain.”
“Americans have more confidence in wireless systems, with payment data being dispatched over large distances. The disadvantage of a wireless system is that it is more open to fraud“, said Lemmens. “In Europe, people prefer ‘tap & go’. You tap your card on the receiver and the transaction clears. One example of ‘tap & go’ is the public-transport smartcard payment system in the Netherlands.”
The portfolio manager has a number of competing names in his fund, as it is not yet clear who will win the race. “I select different companies that are well positioned. I invest in the major credit-card companies such as Visa and MasterCard. These concerns have the most advantageous starting point, although there are parties trying to process payment transactions without them. And I also invest in companies on the security side. They are involved in making payment systems more secure.” According to Lemmens, security is the crucial link in electronic payment traffic.
Some 17% of the portfolio (as at end January 2014) comprises companies active in electronic and mobile payments. The remainder within Digital Finance are mainly involved in electronic exchanges and businesses that provide outsourcing, such as IT operations for banks.
Digital Finance is the trend that makes the fund most distinct from others. In Europe, there are no other funds that invest as much in companies operating in this segment.
Major tech concerns like Apple and Google are also looking at mobile-payment options. However, Lemmens is not investing here, as they only derive a minor portion of their earnings from payment traffic, but he does keep a close eye on these firms. “Until now, these major players have been mainly occupied with new patents such as fingerprint-recognition technology for identifying buyers and securing mobile payments. But they could take the path of acquisition to gain access to winning technologies, and it's those takeover candidates that are especially interesting to investors.”
The Emerging Finance trend focuses on the growth of the middle class worldwide. This trend offers investors low market penetration, high profitability and high growth. Lemmens makes a distinction here between three types of companies:
Despite the volatility in emerging markets, Lemmens does not hedge his currency exposure. “If you invest in emerging markets, you do so because you believe in the potential of those markets over the longer term. So I am prepared to take on the currency risk,” he said. “Hedging is expensive and costs a lot of return. I believe more in limiting risk through wide diversification across different countries and companies.”
Aging Finance, the combination of aging and the need for proper financial planning throughout life is a trend that has been around for a long time. It was one of the reasons behind the great popularity of insurer stocks in the nineties. But this trend has sunk into obscurity among investors, according to Lemmens. “Because governments cancelled many tax measures that ensured money could be saved for later on a tax-friendly basis.”
There are three reasons why he expects a comeback for this trend among consumers and investors:
“Firstly, interest in saving for later is returning. Many people are realizing that they need to take action; otherwise they might not have anything to live on later. What's more, they are expecting less government help in terms of a state pension.”
“Secondly, more and more people are retiring in the US, the UK and the Netherlands. They must buy a pension on retirement that pays out periodically, and engage an insurer to arrange this.”
“Thirdly, the pension-fund sector is subject to increasing consolidation and outsourcing, allowing insurers to expand their assets under management. More and more smaller pension funds are looking to connect with large insurers or asset managers. This is happening under pressure from regulators, who are tightening the requirements that pension funds must comply with.”
Within the portfolio, Lemmens focuses on insurers in both developed and emerging markets. “Both are growing. In developed markets, it's aging that is leading to growth, and in emerging markets, it is the accrual of pensions.”
“But I also invest in financial planners. People are demanding greater insight into their financial situation so they can retire in comfort in future. Finally, I also invest in companies that offer absolute returns, like listed private-equity firms and hedge funds. Investing in businesses that generate absolute returns is a subtrend that ensures diversification in the portfolio,” he said.
Each trend is good for about one third of the portfolio. But to improve his portfolio's risk profile, Lemmens looks deeper. “I look to subtrends within a trend that have a low correlation. And within the subtrends I also look to different companies. Good diversification is the best way to benefit from these three trends.”
Interview with portfoliomanager Patrick Lemmens
This article is written as part of a series of articles for the Robeco World Investment Forum on how long-term trends influence investments.
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