The Digital Finance Tide Remains Unabated
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FinTech Outlook 2021: The digital finance tide remains unabated Digitalization of financial services remains a powerful driver of growth Regulators tighten their grip on tech globally, in particular fintech M&A and IPO activity should continue to recover in 2021 Having weathered the CovidCovid----1919 storm of 2020, the fintech industry should remairemainn resilient in 2021. Even though pandemicpandemic----relatedrelated challenges may persist, fintech remains supsupportedported by a powerful growth trend ––– the digitalization of financial services ––– that has come out unscathed bybyby the turmoil. In this context, we highlight three mamainin investment themes for 20212021.... As we enter 2021, the fintech industry remains underpinned by the brisk digitalization of financial services. This secular growth trend was actually reinforced by the Covid-19 crisis, as social distancing measures boosted the need for digital finance. This is especially true for payments, as consumer habits acquired during the pandemic are likely to persist (see Figure 1). Yet, much of the industry’s strength this year will depend on the actual path to the post-Covid-19 ‘new normal’. Although the gradual recovery that started in the second Article quarter of 2020 remains on course, the upcoming months For professional investors remain uncertain. Depending on the speed and success of January 2021 vaccination campaigns, especially in developed countries, as well as the ability of governments to avoid a third wave of Patrick Lemmens, Michiel van Voorst and contagions this spring, mobility restrictions may ease at a Koos Burema, portfolio managers faster or slower pace, which would have important consequences for business activity. One of the key lessons from the Covid-19 pandemic, and in particular of the great lockdown in the spring of 2020, has been that many incumbent financial institutions lack the flexibility and the capabilities to thrive in a world that is becoming increasingly digital. We see constant shifts in market share and have noticed clear examples of fintech firms proving much better at helping customers adjust to the new situation. Figure 1 | US ecommerce as a percentage of adjusted retail sales skyrocketed in 2020 Source: US Department of Commerce, J.P. Morgan, Robeco. Note: Adj. Retail Sales excludes food services & drinking places, automobile & other vehicle dealers, and gasoline stations. A good example of this ability to react quickly to a rapidly changing situation is US payment company Square, which saw almost a third of its merchants going virtually cashless within just eight weeks, in March and April 2020. The company was able to help its customers by offering the tools and infrastructure necessary to move business activity online quickly. Doing so, Square offered these merchants a lifeline to survive in these unprecedented times. 1 Meanwhile, many incumbent financial services providers simply lack the seamless technology stacks to match their flexibility and efficiency. The Covid-19 pandemic and the related social distancing measures have made very clear that many traditional banks and insurers still need to make significant IT investments, in order to keep up with the ongoing rapid digitization of the financial world. Such investments have become especially critical for back and mid-office operations (see Figure 2), which brings us to the most important investment fintech theme to watch in 2021, digitalization and data collection. Other themes to watch include regulation and big tech, as well as mergers and acquisitions (M&A) and initial public offering (IPO) activity. In the following sections, we provide some background on these three themes, why we believe they offer attractive investment opportunities and how we intend to play them. Digitalization and data collection As we move towards a still elusive new normal, one thing is clear: we have moved to a much more digital world. This is obvious for consumers, who have massively embraced ecommerce, and for employees, for whom remote working has become commonplace. But this is also true for companies, as well as central and local governments, that were forced to adapt to social distancing almost overnight. 1 The information provided in this article does not constitute a buy, sell or hold recommendation for any particular security. The information shown is only available for illustrative purposes only. No representation is made that these examples are past or current recommendations, that they should be bought or sold, nor whether they were successful or not. 2 | Article - For professional investors - January 2021 For those financial institutions that had barely started moving their IT systems to the cloud, the shock was a wake-up call. Meanwhile, those banks and insurers that had already embarked on that journey experienced a smoother transition. Still, most players are expected to keep investing heavily in 2021, despite economic uncertainty. Even as the pandemic recedes and mobility restrictions get lifted in 2021, the bitter lessons learned from the 2020 lockdowns will keep pushing investments. The digitalization tide has become so pressing that banks and insurers can no longer wait for their revenues to recover from the economic slump, or for cost-cutting initiatives to eventually materialize to invest in their core IT systems, or in areas such as artificial intelligence (AI) and cybersecurity. This should keep boosting demand for cloud-enabled solutions this year, including software as a service (SaaS), banking as a service (BaaS) and application programming interfaces (APIs). In fact, over the past few months, many fintech enablers, companies that help incumbent financial institutions digitalize, have been working hard to figure out how to not only sell online, but also how to implement and maintain their products and services remotely, even as mobility restrictions were eased globally. These advances should lead to additional efficiencies and potentially higher operational leverage for these companies going forward. Figure 2 | Unsupported middle-and back-office operations can spoil last-mile experience Source: Robeco, based on: Capgemini Financial Services Analysis, 2020; World Retail Banking Report, 2019; Celent, 2019; The Financial Brand, 2019; Signicat, 2018. We therefore see opportunities in fintech firms that help traditional players digitalize further, in particular through technologies built around cloud computing and SaaS. For this perspective, it interesting to remember JP Morgan Chase’s CEO, Jamie Dimon, admitting – back in 2019 – that the bank had been “a little slow in adopting the cloud”. Dimon said he initially thought ”the cloud was just another term for outsourcing and that the bank’s own data centers could perform just as well”. 3 | Article - For professional investors - January 2021 Cloud solutions offer superior computing power and flexibility to scale up systems quickly. Even a bank with an annual IT budget of over USD 11 billion is relying on outside help. It is moreover interesting to observe that relatively small and young SaaS software companies can win substantial contracts, and hence scale up more rapidly than ever before. We invest in a basket of companies, like nCino, Duck Creek and Sapiens, to benefit from this trend. Linked to this, we are seeing rapid advancements in AI technologies, including machine learning (ML), in a cloud-based environment, that allow for innovation in payment solutions and online lending. Most traditional financials rely on traditional credit risk-scoring methods. But Chinese internet giants, like Alibaba and Tencent, have ventured into new methods of credit assessment using sophisticated data analysis to predict credit behavior. We are seeing an increasing number of companies emerge around the globe, offering similar approaches. The main advantage is to improve credit availability to segments of the market, that are typically underserved, or not served at all, at a lower cost and with better credit experience for the lender. Doing so, these companies are able to improve financial inclusion while achieving lower loss rates at the same time. On the data collection front, 2021 should also be a very interesting year. As AI algorithms improve and growing amounts of data get collected around the world, in areas ranging from customer preferences to corporate sustainability practices, databases and analysis tools for commercial applications become increasingly critical, and may in some case represent attractive investment opportunities. Rising demand for data on sustainability provides a good illustration. As sustainability awareness improves and reporting requirements increase, gathering and providing data on these issues has become a fast-growing new business for many players. In particular index providers, such as MSCI or S&P Dow Jones, have stepped into the breach. But exchange operators, like London Stock Exchange, Nasdaq and Intercontinental Exchange, have also made significant investments in this area. Some of these firms are actually among our top holdings. Tightening regulatory grip Regulation is back with a vengeance in 2021. Those who thought the financial regulation pendulum was finally swinging back to a looser stance, after years of severe tightening following the great financial crisis, are poised for disappointment. In this context, fintech is likely to come under the regulatory spotlight. Digital currency-related activities, including cryptocurrencies, are an obvious case in point. But many other