TECH & INNOVATION INSIGHTS

The Business Times | Wednesday, September 7, 2022

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Fintech’s transformative power
Fintech is ushering in an era of structural change in financial services. Here are some promising themes and insights on how one may sift for winners
ROUNDTABLE PANELLISTS:■ Matt Lipton, senior managing director
and portfolio manager, Wellington
Management■ Gareth Nicholson, CIO and head of
discretionary portfolio management,Nomura■ Brad McCarthy, Apac head ofalternative investment sales, Citi Global
Wealth Management Investments
Moderator: Genevieve Cua, wealth editor,
The Business Times

FINTECH is slowly and surely disrupting
and transforming the financial services
landscape. Investing in this segment of thetechnology sector has proved both rewarding and challenging.
In this roundtable, our panellists share
their views of the major fintech themes forthe short and long term, and principles
that will help investors sift for potentialwinners.
Q: What do you see as the major andmost transformative technologies,
with the greatest long-term impact on
the way financial services are usedand delivered?
Matt Lipton: While the first half of 2022
was certainly challenging for the fintech
market, my long-term view is that we’re at
the beginning of a decades-long cycle ofdisruption and structural change in the financial services sector, fuelled by 3 key
drivers/technologies:■ Adoption of big data and cloud computing. This may be a universal theme across
many sectors, but it’s early days for financial services. Based on our research, we estimate that 5 per cent of banks can open an
account online for a customer from end toend, and that big data and the cloud will
unlock a solution for a much larger customer base. The online mortgage process
is one area with far too many manual steps
still required and many opportunities todigitise the workflows as new technologies
take hold. Fraud and risk management remain stumbling blocks for most incumbent financials to digitise their business,
which cloud and big data can help overcome. In time, we should see a near-total
rewiring of the financial infrastructure, including the service providers and back-office software companies serving financials.
■ Democratisation of financial services.
Many around the world still lack access togood financial services such as credit andchecking. But apart from digital banks – anextension of traditional banks – neobanks
and tech companies can use digital andmobile technologies to create better user
experiences, access to credit, and investment capabilities. Neobanks, which are exclusively online, can acquire a customer at
about a third of the cost of a traditionalbank but still potentially derive the same
lifetime revenue per customer. The ability
to do it all faster and cheaper is driving
market-share shifts in deposits, lending,and brokerage assets away from incumbents.
■ Financial inclusion in emerging markets. We’re seeing fintech-related disruption in the US and in other big population
centres such as Brazil, India and Indonesia.
It’s creating a more level playing field forthe “under-banked” and helping to repricefinancial products. Fintech companies areoffering more reasonably priced products
to emerging market consumers and taking
share away from incumbents.
Gareth Nicholson: The future of investing as will be largely quantamental investing – the combination of human and machine. It’s the best of both worlds.
Well-trained human analysts can understand how the future may look different
than the past – think of changing industry
structures, emerging technologies, shifting company positions or new industry
regulations. In these situations, machines
focused on historical data are at a disadvantage.
On the other hand, well-developed
computer models are unmatched in automating tasks, analysing how the past may
predict the future and identifying anomalies (ie, automation, prediction, detection).
No human can match an algorithm’s ability
to vet millions of data points in such amanner. Uniquely integrating both presents a logical opportunity.
The common challenge in big financial
institutions is legacy tech – or more specifically, integrating new disruptive technology into traditional banking platforms.
There are huge opportunities for techintegration over the next decade, butbanks will likely need to collaborate extensively with non-bank partners to offer new“I believe we are witnessing
a convergence between
public and private markets
that is creating a more
integrated ecosystem of
public and privatecompanies, and broadly
altering the investment
landscape – giving rise to
hybrid managers and hybridstrategies.”“There are huge
opportunities for techintegration over the next
decade, but banks will likely
need to collaborate
extensively with non-bankpartners to offer new value
propositions that areintegrated across journeys,technology platforms, anddata sets effectively.”

Matt Lipton

Gareth Nicholson

value propositions that are integrated
across journeys, technology platforms,and data sets effectively.
As it stands, it is niche financial sub-sectors that are most adept at harnessing
technological innovations to launch applications, generate value, and shape thecompetitive landscape.
In future, traditional financial institutions will need to accelerate partnerships
or bring their considerable resources tobear to stay on top of the gathering wave offinancial industry disruption.
The greatest long-term impact on financial services: Artificial intelligence (AI) will
drive massive value creation. In investing,automatic factor discovery, or the machine-based identification of the elementsthat drive outperformance, will become
more prevalent, helping to hone financial
modelling across the sector.
As a key application of AI semantic representation, knowledge graphs and graphcomputing will also play a greater role.
Their ability to assist in building associations and identify patterns across complex financial networks, drawing on a wide
range of often disparate data sources, will
have far-reaching implications in the years
to come.
Brad McCarthy: Change has always beena constant in financial services. In many
ways, the global pandemic forced theadoption of digital services by individuals
and companies that had long been resistant to embracing significant change.
This has emboldened financial providers to invest heavily in digital innovation,including the adoption of blockchain technology, to strengthen their operations.
One such example of innovative change
is the proliferation of fractional trading capabilities that have enabled the growth of
discount brokerage firms that rose toprominence during the pandemic.
By enabling retail investors to gain
more democratised access to many of thelargest stocks in the world, we witnessed asurge in the number of new investors whoparticipated in markets for the first time. A
greater number of market participants
with greater access than before will only
help to strengthen and deepen these markets.
The digital transformation of financial
services remains in its early stages as cutting-edge companies are pursuing innovation in the very foundations of finance, including payments, contracts, settlements
and regulatory compliance.
In short, the infrastructure of money isbeing redefined and strengthened in ways
unimaginable just a few short years ago,
and we expect this new trajectory to accelerate in the years to come.
Q: More investors are seeking out private market investing in today’s lowreturn world, and fintech is helping towiden access. What do you see as themost important private investing
trends within the fintech sector going
forward?
Lipton: The large addressable market sizeof financial services, including trillions indollars of deposits, payment volume, andlending activity annually, makes fintech an
attractive investment opportunity for private markets (venture and private equity)
investors.
Growing capital formation in both private markets (by our own estimates,
US$200 billion in fintech venture fundingin 2021) and public markets (over 200 initial public offerings, or IPOs, in the last 24months) is creating increased competition
and investment opportunity.
However, I believe we are witnessing a
convergence between public and private
markets that is creating a more integrated
ecosystem of public and private companies, and broadly altering the investment
landscape – giving rise to hybrid managers
and hybrid strategies.
■ Hybrid managers may benefit from having access to capital during periods of market dislocation, when dedicated private
market managers are experiencing a morechallenging capital raising environment.
Further, hybrid strategies allow investors
to be fully invested at inception, potentially minimising J-curve drag in the portfolio.
This is valuable for building out private
market programmes.
■ Given their unique attributes, hybrid
strategies may warrant a standalone category within a diversified alternatives allocation. These strategies have the flexibility
to benefit from compelling opportunities
across structural winners and losers, both
via long/short and public/private positions.
■ Depending on their exposure and liquidity objectives, allocators may considerusing specialised hybrid strategies to amplify exposure to innovative areas or to fillin gaps. For example, putting more capitalbehind structural megatrends impacting
fintech.
■ Hybrid strategies can also employ
shorting and hedging techniques in thepublic markets to take advantage of the information edge and market volatility created by an increasingly competitive market.
Fintech and financial services are particularly relevant to this convergencetheme as the massive disruption acrossthe global financial system driven by newtechnologies – cloud, AI, digital platforms –is creating intense competition among incumbents and disruptors.
In fact, many large incumbent financial
firms are also heavily investing in private
fintechs through their investment or venture arms.
Nicholson: Two areas of particular interest with regard to more private or alternative markets are access to traditionally illiquid markets and transparency. I think 2technologies offer great opportunities insolving these challenges:■ Blockchain will disrupt established financial products. Technologies such as
smart contracts, zero-knowledge proof,
and distributed data storage and exchange– which are key to existing fintech innovations such as digital wallets, digital assets,
decentralised finance (DeFi), and non-fungible tokens (NFTs) – will continue to play a
prominent role in allowing better access to“The key principles that will
drive important long-term
process improvements for
consumers include the need
to offer greater convenience,lower costs and better profit
margins for users, while
maintaining the high-trust
environment expected fromfinancial services.”
Brad McCarthy

private markets■ Internet of Things (IoT) will drive a newera of trust in finance/transparency. From
the financial applications perspective,
consider the fact that environmental, social, and corporate governance (ESG) considerations now govern many investment
strategies and regulatory policies. For instance, several major countries have committed to achieving peak carbon emissions
and carbon neutrality. Aside from broader
use of renewable energy, success inachieving these goals will be predicated on
the effective monitoring and managementof industrial energy and power efficiency.
This presents a perfect scenario for IoT applications. Carbon trading, for example,
will be increasingly indexed to IoT measurements, opening new opportunities for
astute players.
McCarthy: There are 2 key areas where wehave seen a surge in interest within the private fintech space: data aggregation andcybersecurity.
In an increasingly connected world,such as one powered by Web 3.0, the explosion of data created each day is truly
breathtaking.
According to Statista, prior to the startof the pandemic, there were roughly 44
zettabytes (44 billion terabytes) of new data produced each day around the world.
In 2022, that number has jumped to 97
zettabytes each day, and by 2025, it is expected to double again.
There is an enormous amount of insighton many fronts that can be gained by
combing through this data, and what we
see today in private markets is somethingof an arms race to find new applications
that can help to do so.
The other side of the same coin is thegrowing concern about the safety and security of this data. Unlike physical assets
where visible deterrents such as lights orcameras can help deter bad actors within
their proximity, digital assets, such as data, require rapidly evolving security measures to protect from new threats from all
corners of the world.
For this reason, cybersecurity will remain one of the fastest growing areas within private markets for many years to come.
Q: An environment of higher interest
rates, higher inflation and lower
growth has caused a valuation reckoning in the fintech sector. What principles do you pursue in discerning between potential winners and losers in
the fintech space?
Lipton: The current market notwithstanding, we think every financial institution
will face decades of disruption from both
existing competitors and new fintech entrants; investors may expect dispersion
and volatility to remain for some time.
The reason for this is that the global
economy has been over-served with stimulus, and central bankers globally are now
making adjustments. Fintech was at theepicentre of a move to low interest rates,unprecedented stimulus and wild valuations.
In fact, there were over 200 fintech IPOs

in the last 24 months, with share prices
down over 50 per cent on average from lastyear.
While that may look enticing to many, I
think the party is over, because generalprojections miscalculate the challenges offinancing and credit costs for many fintechs.
As financial services specialists, wesearch intently for the intersection of incumbent weakness and entrants withstrong models; and I believe amazing financial change is right in front of us, but
having the right bottom-up company calls
is key to success.
Going forward, there will be a greater
emphasis on businesses with moats andwinning unit economics.
There are a couple of areas to watch:■ The new environment is one wherelong/short stock picking is potentiallybeneficial. We are now seeing companies in
the payments and challenger bank spacewith entry points back at 2018 levels, despite the business being 3-5 times larger.
There are also compelling short opportunities as well – companies with poor fundamentals that may burn through their liquidity in the next 12-24 months amid a difficult capital markets environment.
■ In the private markets, embedded finance infrastructure and platforms are ofinterest, whereby financial services will
become more intuitive and ingrained inour daily workflow, prevalent across everymain street business. Owners can manage
their checking account and loans in thesame application they order inventory andmanage payroll. Similarly, consumers canshop, save, borrow and pay on single applications.
Nicholson: Success will require morethan hiring some people and telling everyone to get to work with the tech. To be successful, each firm faces a similar but distinct challenge: discovering how to best integrate new technologies with their humantalent pool given their unique objectives,skills and experience.
No-code and low-code will redefine application development and are particularly attractive.
No-code development platforms, andtheir close relation low-code platforms, allow programmers and general users to develop applications through graphical userinterfaces and configurations (for example, drag-and-drop) instead of traditional
computer programming. This opens up
great synergies for traditional investors toshare skills and enhance traditional methods to cater for the huge increase in dataand scale required.
McCarthy: Despite the market conditions
experienced this year, we maintain astrong conviction that fintech is an unstoppable trend.
In considering investments, it remains
paramount to consider factors such as acompany’s total addressable market, rates
of adoption, and the potential to become
category leaders.
The key principles that will drive important long-term process improvements for
consumers include the need to offer greater convenience, lower costs and better
profit margins for users, while maintaining the high-trust environment expectedfrom financial services.
Quality of capital structures as well as
quality of business will also matter. We
have observed a bifurcation in private markets between businesses with strong andweak balance sheets and capital needs.
In prior years, when capital was moreabundant, management teams that hadforesight enough to raise excess capitalwould enable their companies to survive
and likely thrive.
This will come at the cost of companies
whose management teams were not as
proactive and whose balance sheets andfunding positions are weaker. The moreproactive management teams will also
benefit from the potential to make acquisitions of other private market firms and further strengthen their competitive positions.
The current valuation environment
would provide investment opportunities
across all fintech segments.
In this environment, an investor shouldbe able to find opportunities to match theirtechnology risk appetite from establishedcompanies to untested transformativetechnologies.

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