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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 increasingly important in the wake of the COVID-19 pandemic. Financial institutions with more modern technology have been able to adapt to an increasingly digital customer base and workforce.
Beyond helping to solve many of the challenges presented by a global health crisis, the transition to digital typically makes these processes cheaper, creates better risk-adjusted outcomes, and often results in better end-customer experiences. Historically, 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 in the crisis, we’ve seen technological adoption accelerate quickly. Importantly, 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 digital transformation
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 has been hastened by the pandemic but is still quite 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 shows how the leading electronic bond-trading platform is gaining share of the total credit trading markets. While growth has been strong in recent years (at over 10% per year), market penetration is still low (at roughly 20%).2 We believe this exemplifies 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 1.5 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, and adoption has only been accelerated by the pandemic.
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. Since 2015, the demand for investing has been exploding and broadening. Notably, Brazil is more digital than many EM countries, making human interaction with customers a less-relevant hurdle. This trend was further highlighted in the wake of the pandemic.
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.
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. During the crisis, this type of technology has been 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.
Digitization offers opportunity, access, and transparency
The recent global health crisis has helped to prove the critical nature of digitization. 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. This is the latest data available from the source. | 2Sources: Company Data, TRACE. Data as of 31 December 2020. | Sources: World Bank’s Global Findex Database, December 2017. Wellington Management estimates, December 2020.
- Emerging markets