The digital transformation of financial services

We highlight the fintech innovations driving the digitization and disruption of financial services.

The views expressed are those of the authors at the time of writing. Individual teams may hold different views. The value of your investment may become worth more or less than at the time of original investment. For professional or institutional investors only.

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.

The shift to digital typically makes these processes cheaper, creates better risk-adjusted outcomes, and often results in better end-customer experiences. However, for new fintech companies, customer connectivity and trust can take a long time to develop as consumer behavior can be hard to change when it relates to financial decision making. But once these businesses reach scale, we think they tend to be highly profitable and sticky.

In this piece, we highlight the broad opportunity offered by the digitization of financial services and profile a few key areas (and companies) we find particularly exciting.

A long runway for digitization

In our view, countless manual processes across each vertical have 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. As an example of the sheer scale of the potential growth, emerging markets (EM) GDP could increase by approximately US$3.7 trillion by 2025 if digital finance is widely adopted.1

We believe this opportunity is still early in its growth curve and expect the trend to persist throughout the 2020s. 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

Strong historical growth with a long runway

The top charts in Figure 1 show how the leading digital Italian financial services company is gaining share steadily in the total Italian savings market. The bottom charts show how the leading electronic bond-trading platform is gaining share of the total credit trading markets. While growth has been steady in both areas in recent years (8% in digital savings and 11% in electronic bond trading), market penetration in still low (2% in digital savings and 20% in electronic bond trading.2 We believe these exemplify the opportunity set’s long, stable runway for 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 local demographics. We therefore believe deep subsector expertise across financial technology is critical to finding opportunities within these diverse markets.

Opportunity and accessibility through digital platforms

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 two billion adults do not have access to a bank account. 3

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 digital financial products and services is therefore expanding globally at a rapid rate.

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 the 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. But interest rates have come down significantly over the past few years, leading to a broader investment culture. In our view, this company offers a simple, low-cost, and digital way for Brazilians to invest their savings and we think the social impacts for its customers will be profound. Since 2015, the demand for investing has been exploding and broadening. Given the size of Brazil’s population and GDP, we believe the scale for this company to grow is just as significant. Notably, Brazil is more digital than many EM countries, making human interaction with customers a less-relevant hurdle.

Many online platform providers such as this have been successful at expanding 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.

The benefits of systematized decision making

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 utilization 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 the bank and broader credit availability for the economy.

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.

figure 2

Digitization offers opportunity, access, and transparency

We believe innovations driving the digitization of financial services will continue to disrupt the industry throughout the 2020s. 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: McKinsey Global Institute, “The Promise of Digital Finance,” December 2016. | 2Sources: Company Data, TRACE, Associazione Bancaria Italiana | 3Combined Wellington Management estimates as of 31 December 2019.

Please see the important disclosure page for more information.

Please refer to the investment risks page for information about each of the following risks:

  • Capital
  • Concentration
  • Emerging markets
  • Equities

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