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Across every vertical of the financial services industry, innovators and disruptors are increasingly applying modern technology to digitize (and improve) processes that used to be performed manually. This shift has become near essential as financial institutions with more modern technology have been better able to adapt to a more digital customer base and workforce in the wake of the COVID-19 pandemic. Notably, despite the recent macroeconomic downturn, we believe this trend will persist as spending on mission-critical technology and digital transformation remains a top enterprise priority across financial services as well as the broader economy.
The transition to digital typically makes processes cheaper, creates better risk-adjusted outcomes, and often results in stronger end-customer experiences. Historically, for new fintech companies, customer connectivity and trust took a long time to develop as consumer behavior can be hard to change when it relates to financial decision making. But because of the pandemic, technological adoption has rapidly accelerated. Importantly, once these fintech businesses reach scale, we think they tend to be highly profitable and sticky.
In this piece, we highlight the broad opportunity offered by the digital transformation in financial services and profile a few key areas we find particularly exciting.
Though we’ve witnessed substantial progress in recent years, it is our view that countless manual processes across each vertical have still not yet been digitized. This offers a wide and long-term opportunity set as human processes — previously done by bank employees, financial advisers, traders, etc. — will be increasingly enhanced by digitization.
We believe this opportunity has been hastened by the pandemic but is still quite early in its growth curve and we expect the trend to continue throughout the 2020s (and beyond). Many of the leaders in this space have grown consistently at 10% – 15% CAGRs (compound annual growth rates) for years, but their market shares remain small, potentially offering long runways for growth (Figure 1).
Figure 1 shows how a leading electronic bond-trading platform is gaining share of the total credit trading market. While growth has been strong in recent years (at over 10% per year), market penetration is still low (at roughly 25%).1 We believe this exemplifies the opportunity set’s substantial for long-term future growth as penetration rates steadily grow.
Importantly, this opportunity stretches across every asset class and the potential “winners” appear to be distinct in every geography. Local companies have thus far been better able to cater to the distinct needs of local populations. We therefore believe deep subsector expertise across financial technology is critical to finding opportunities within these diverse markets.
Large segments of the world’s population still do not have access to fairly priced banking options or convenient ways to invest their money. For instance, approximately 1.4 billion adults do not have access to a bank account.2
To help serve these populations, online investment platforms are digitizing their product sets to provide easily accessible, cheaper, and less complex offerings in comparison to traditional banks. Fortunately, access to and adoption of digital financial products and services has been expanding globally at a rapid rate in recent years.
In particular, these companies are greatly improving accessibility in emerging markets. New online services make investing easier in markets where many have not historically had easy access to a bank account or brokerage services. One such example is a leading digital investing platform in Brazil.
For many years, Brazil’s onshore retail investing market was narrow and limited to buying high-yielding government bonds. However, the rise of easily accessible digital offerings has led to a broadening of investment culture, and since 2015, the demand for investing has been exploding. Notably, Brazil is more digital than many EM countries, making human interaction with customers a less-relevant hurdle, which was particularly significant in the wake of COVID-19.
Many online platform providers such as this have successfully expanded their existing customer base into adjacent product sets. For example, a digital investing platform can more easily cross-sell existing customers into its banking, lending, and insurance offerings as it has already established connectivity and trust. As digital platforms develop and then broaden to adjacent products, we think their underlying customer populations will further benefit from increasing opportunity and accessibility.
Market data surrounding financial transactions and information has long been opaque or simply unavailable. But as the digitization of financial services develops, owners of this data are realizing they possess extremely valuable assets. New technologies like the cloud, artificial intelligence, and machine learning are allowing firms to harness this data to improve their decision making. Increasingly, financial analysis is therefore becoming systematic and data driven.
Software providers and data owners are the critical arms merchants to legacy financial services firms trying to “systematize” their businesses. Improving the use of technology and data can materially enhance their businesses, but companies must have both the data and a technology platform that can handle the types of analytics required for higher volumes of data. For example, loan officers previously met loan applicants to evaluate their creditworthiness and approve or reject applications. New software can help companies harness their data to create more scalable and efficient digital processes to price loans, leading to better credit outcomes for banks and broader credit availability for the economy. During the peak of COVID-19 lockdowns, this type of technology was essential to many financial services companies as in-person meetings were not possible.
In Figure 2, we highlight a firm specializing in direct and fund-of-fund investments whose business model is based on leveraging its long-held proprietary database of private-market deals.
Though we are confident in the enduring secular tailwinds driving the digitization of financial services, there are several important risks to this opportunity set. The key risk, in our view, is the pace at which digitization might occur. Historically, regulatory oversight in the financial services industry has often slowed the rate of innovation. Regulation also varies greatly by region, which has made it challenging for companies to scale globally. Additionally, technology infrastructure is critical and complex in the financial services industry, which moderates the pace of change as decision makers know there are substantial consequences for a disruption or breach. Finally, the pandemic was an obvious catalyst for widespread digitization, but as companies around the world deal with a variety of macroeconomic pressures – such as inflation and rising interest rates – could digitization's progress slow? Despite being a top enterprise priority, the answer is likely yes.
Critically, however, we believe the innovations driving the digital transformation in financial services will continue to disrupt the industry throughout the 2020s, fueling long-term growth potential regardless of any near-term macroeconomic weakness. Importantly, along with providing an incredible breadth of investment opportunities, we think these developments have the potential to offer unparalleled opportunity, access, and transparency to new regions and markets.
1Source: Company data. Data as of 31 December 2021 | 2Source: World Bank’s Global Findex Database, December 2021.
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