Investing in financial services businesses : stay open minded

Andrew Lee, Investment Director at Capital Group based in Hong Kong Crédit photos : Capital Group ; Illustration : Maison Moderne

Andrew Lee, Investment Director at Capital Group based in Hong Kong Crédit photos : Capital Group ; Illustration : Maison Moderne

Keep an open mind when considering investing in financial services players”, says Andrew Lee, Investment Director at Capital Group based in Hong Kong, speaking on the Paperjam/Delano ’Investing for the long term’ podcast. In an industry under strain from regulation and tough markets, some companies are reinventing their niches.

Deep market trends powered by changing consumer demand and technology are impacting a range of financial services players. These trends are affecting banks, but progress can be slow. However, interesting market dynamics are at play in the niches of the financial sector. And it’s the companies best able to harness these that are positioned to benefit.

The global exchange industry has undergone a major transformation over the past 20 years,” Mr Lee said, citing one example. These marketplaces see all manner of financial instruments and commodities traded, but the old reality of utility institutions operating person-to-person “open outcry” communication has gone. Now we have consolidated global data-driven online networks processing high volumes of transactions, but also offering value-added services.

Trading is a high margin business, with futures being the largest and most attractive asset class,” Mr Lee said. “But exchanges are now also market infrastructure providers, and these are a second growth driver: data vendors, custodians, infrastructure and financial technology providers.” He says that this segment has a revenue pool six to seven times larger than trading. “Exchanges sit at the confluence of powerful secular trends: the growth of financial markets, of derivatives, and above all they have data,” he said. They can also leverage their dominant position in trading.

This suggests that, as well as organic expansion, they are well positioned to make acquisitions. Mr Lee pointed to the London Stock Exchange (LSE) Group which purchased the major data provider Refinitiv. “Market execution is estimated to make up only about one-third of the company's revenue, with the rest coming from data,” he said. Moreover, this is recurring revenue creating counter-cyclical revenue flows. Similarly data-driven are rating agencies. Having a credit rating has been a must-have for many investment products, and again this creates a regular income stream for those agencies, and those investing in them.

FinTech is mostly thought to be about start-ups, but this is also for industry incumbents that use technology effectively. As well as the insurgents, it is important to take a close look at which incumbent institutions are technology leaders. “Many banks in developed markets have been relatively slow to invest in technology, but some have accelerated this in recent years, and this is starting to show in results,” he said.

Technology is also creating new markets. “FinTech companies initially focused on digitalising existing products and services, but with FinTech 2.0 we have products that did not exist before such as digital wallets, buy-now pay-later services and robot advisors,” said Mr Lee. There are also companies outside of the financial services sector using their ecosystems and technologies to enter the industry, including Tencent, Amazon and Meta.

Financial technology works well in Asia, where fast-growing economies with their emerging middle classes have few preconceived ideas of what a financial services firm should look like. “Several multinationals, such Hong Kong based insurance company AIA, have great distribution networks in these economies and have shown the ability to manage their liability profile, while effectively deploying FinTech,” he said.

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