If you haven’t yet heard, there is currently quite a bull market in all things Fintech-related. Every day, there’s a new headline proclaiming how the newest Fintech company will disrupt the big banks and change the financial services status quo.
New, digitized models will change how payments are made, money is lent out, and how Mr. and Mrs. Smith invest their retirement savings. However, what everyone hasn’t been talking about much is how this new area of disruption is going to affect, perhaps the biggest and most influential pool of capital of all, institutional investment management.
According to CB Insights, investments into Fintech companies in 2015 totaled $19 billion. That’s a 58% increase from the $12 billion invested in 2014, and over a 1,000% increase from 2010.
Source: CB Insights, Citi
So what is the big draw that’s attracting all this funding activity? For the most part, it’s the recognition that large consumer banks have not exactly kept pace in delivering new, engaging models that provide value-added services to their customer base. And like so many others industries that have been slow to embrace innovation, consumers — with new digital skills — will gravitate to frictionless processes (and companies) that best serve their evolving needs. The banking sector has been slow to transform existing models, paving the way for new entrants to capitalize on these inefficiencies.
The focus to date in the Fintech sector has centered around five main areas: Consumer lending, payments, personal finance, money transfer and bitcoin. Each sector represents a fundamental new way in how consumers lend, spend and invest their money. One only has to look at PayPal ($PYPL) as an example of a company that has had a tremendous impact on payment efficiency.
Information Advantages Drive Value
The one obvious aspect of this new paradigm is the venture industry’s laser focus on the consumer. This makes sense given the enormous opportunity. What is somewhat lacking in representation are new ideas and processes to improve how money is allocated in the vast capital markets, where the vast majority of all our pension savings are managed. Trillions of dollars are exchanged every day in the currency, bond and equity markets. Arguably, any inefficiencies in these markets are what creates value: Seizing upon opportunities where an information advantage exists to be exploited by one market player over another. Advantages, though, are predicated on having timely information, a system of execution and good judgment. Value (and alpha) is created from being “on the right side of the trade.” The impact of institutional capital on the world economy cannot be overstated. Similar to the consumer model, a tremendous opportunity exists to provide the institutional community with new tools and processes to drive efficiencies in how capital is allocated, beginning with how information is discovered, captured, organized and acted on. Information, after all, is the lifeblood of the investment decision making process.
The Need for Innovation in Capital Markets Tools
The capital markets have not been without innovation. Millions of dollars have been spent on developing new trading, risk management and execution systems. A number of these systems have come to market from the development of in-house proprietary technologies. Blackrock Solutions and Arcsesium from D.E. Shaw are good examples. New technologies that address front office solutions have been less prevalent, such as those driving information efficiencies to make better investment and portfolio management decisions, e.g.: AlphaSense. The main solutions tend to be legacy, terminal-based systems or old client-server platforms, but these systems lack the same innovations that are being brought to the consumer market. Indeed, the open, SaaS-based models of the newly heralded Fintech tech market are now finding their way to the institutional capital markets.
A Place for Invest-Tech
“Invest-tech” represents an opportunity set that is beginning to be noticed. The same Fintech innovations for consumers — mobile, search, frictionless transaction — are now beginning to transform the way capital is allocated in the equity and bond trading markets. An investment firm that finds their fundamental research process unable to capitalize on new technologies that deliver better insight into the markets will soon find themselves on the wrong side of the trade.
1. AlphaSense, Search Engine For Financial Professionals, Raises $33 Million, Laura Shin, Forbes.com, March 6, 2016