Investment strategies targeted exclusively at the convergence of financial services and technology have become commonplace. As competition picks up, success will depend on adopting skills and a global view
Specialist Investment in financial technology is often relegated to the fringes of the global private equity industry. But with cryptographic token sales now established as one of the dominant forces in equity funding and finely targeted fund launches starting to penetrate some of the unlikeliest jurisdictions, it’s getting harder to peg the phenomenon as anything but mainstream.
Token sales – also known as initial coin offerings (ICOs) – surpassed conventional seed-stage investments this year with substantial support from a new crop of fintech-focused GPs, including Pantera Capital, Blockchain Capital, and Kryptonite1. Meanwhile, a number of geographies typically considered too underdeveloped for niche strategies are seeing a rapid proliferation of fintech funds and managers.
Thailand offers a good example of how this brand of specialization has become entrenched outside of the usual hubs. The likes of Kasikorn Bank, Bangkok Bank, Government Savings Bank and Siam Commercial Bank have all launched fintech investment programs, while Expara Thailand will focus strongly on fintech as co-manager of the government’s SME Private Equity Trust Fund program. Indeed, Expara’s experience in the sector is probably the main reason for its selection as one of the managers.
Importantly, these plays aim to leverage the inherent interconnectedness of payments, transaction data, credit services and insurance to accelerate growth in more concrete industries. They therefore highlight the notion that fintech specialization may not be as vertically limited as it first appears. However, as major financial institutions begin to replicate start-up offerings in-house, questions around how the ecosystem will fair across a five-year life cycle are likely to become more acute.
“I think fintech generally is in line for a bit of a shake-out over the next few years, and the specialist investors will be a key element of that,” says James Lloyd, Asia-Pacific fintech lead at EY. “The most interesting fintechs in the region may not even self-identify as such. We’re seeing considerable convergence across industries – which is why ride-hailing apps, for example, are moving into financial services. The smarter guys in this space are retaining some level of optionality because the overlap with other industries is significant.”
The general consensus is that the fintech space as a whole is growing rapidly, despite a lag between enthusiastic industry chatter and on-the-ground implementation. As such, the mood remains buoyant but balanced uneasily on philosophical discord about defining the opportunity. The two mains schools of thought see fintech as either the birth of an entirely new sector or simply a routine digitization phase.
This vagueness has nevertheless allowed the opening of doors across a number of asset classes, verticals and service lines, while proving that the category has sufficient scope to accommodate specialist investment – at least for the moment. China, alone, is believed to uphold this argument, having produced the world’s largest fintech start-up in Ant Financial, an Alibaba Group unit that raised a $4.5 billion Series B round last year at a valuation of $60 billion.
The rise of fintech-only investors, however, is a much less Sinocentric affair. As the eruption in Thailand helps illustrate, deep diffusion of the concept is likely tied to its potential to function as an omnipresent, class-agnostic platform play. “The reason you’re seeing a lot more specialization in fintech and financial innovation is because financial solutions are basically the oil that greases the engine of society,” says Ganesh Rengaswamy, co-founder at Quona Capital. “It’s inextricably linked to people’s everyday lives, and hence, there are a lot more applications than in the limited Wall Street view of finance.”
Quona describes itself as the first global fintech fund manager to focus on small business lending, financial services and advisory for unbanked and underbanked people in emerging markets. In March, it closed a $141 million global fintech vehicle alongside Accion International, a non-profit that maintains a parallel fintech-only fund known as Venture Lab. LPs included Mastercard and J.P. Morgan.
Although the Quona-Accion partnership is a firmly commercial venture, it does maintain an impact component that could represent the most convincing thesis for fintech specialization. The idea is that regions such as South and Southeast Asia offer investors a gap to fill due to local offsets between skyrocketing mobile penetration and a lack of physical distribution infrastructure for financial services.
Apis Partners, a growth equity fintech specialist also focused on emerging markets, has made six investments under this premise since 2014 and closed its debut fund in March at $287 million. It expects companies coming out of these markets to ultimately expand into developed economies because they are created without the baggage of legacy infrastructure to be lean and inexpensive.
“If you look at the Blackstones and the KKRs, they all have specialist teams now within their organizations that do what we do because they recognize that in order to play in this space, you need to have specialist people,” says Udayan Goyal, a co-founder at Apis, who traces his experience in the sector to the late 1990s. “The problem with that approach is they’re doing it part-time without the full dedication of a team that’s been doing it for 20 years. I think that’s a big differentiator.”
A number of fintech-focused investors, including Goyal, see these advantages as slowly squeezing highly diversified managers out of the sector at both the early and growth stages. The first traces of this trend can be seen in the market dominance of generalist GPs that have already doubled down on fintech. Advent Venture Partners, Hellman & Friedman, and Silver Lake are typically namechecked as technology generalists that demonstrate the virtues of more precise domain expertise by leveraging reputations built on repeat investments to control the global market.
“Founders in the fintech space often have specialized products in credit, payments, savings and technical areas where most investors are not well versed, so they want someone who has that background,” says Tahira Dosani, a managing director at Accion Venture Lab. “You’re only able to provide support if you understand these businesses, so that’s where specialization adds value. When I sit across the table from an entrepreneur starting a business, I know they want to hear about how we’ve already invested in a few other similar businesses and what we learned by doing that.”
Fintech specialization is also justified by a growing consensus that financial services are at an historic inflection point, with new markets and infrastructure demanding an overhaul in industry engagement at all levels. From a global perspective, Asia is seen as a natural leader in this step-change due to the region’s rapid progress transitioning banking from high-income privilege to mass market product.
Industry outlooks in this context often include a proliferation of specialized GPs in emerging markets with social agendas as well as an increased focus on sub-specializations such as insurance or blockchain, payments and wealth asset management. This development is expected to accelerate as e-commerce and payment protocols become increasingly indistinguishable.
Furthermore, as this business model evolution unfolds, the logic of sub-specialization may be supported by the notion that many of the earliest investors are likely to be the engineers of large organizations who are spinning out their own funds with a limited capital base. In Asia, regulation and consumer environment advantages may further facilitate this process.
“As we’re seeing with the FCA [Financial Conduct Authority] in the UK, the MAS [Monetary Authority of Singapore] in Asia is doing great things to provide an open, progressive regulatory framework, enabling fintech to flourish and provide a stable and professional environment for investment to satisfy the growing demand,” says Michele Tucci, head of strategic partnerships at Moscow-headquartered Finstar Financial Group.
Finstar makes private fintech investments globally with a focus on underbanked populations. The firm, which last month committed to invest $150 million in the sector across the next five years, sees Asia as a uniquely complex market but one that compares well with Europe and the US in terms of scalability. Tucci cites headwinds in the region around reconciling an environment of some 50 languages and a matching range of consumer attitudes and needs.
“From this point of view, it’s easier to do business in Europe, where, for instance, lending and payments licenses can be easily passported across countries,” he adds. “To succeed in Asia, a fintech company needs to plan not only for scale and volume across geographies but also for different legal set-ups and customized operations.”
For small specialist GPs, coping with these challenges will sometimes be a matter of bringing in contracted third-party help. This may prove to be an unworkable approach long-term, however, since it deprives in-house teams of experiences that would normally inform future investment decisions. Outsourced consultants may also be insufficiently accessible to address the operational spot fires associated with early-stage companies.
So far, the strategy of existing fintech specialists has been to develop purpose-built teams with as much technical knowledge as possible. Despite these intentions, though, most fintech-only investment teams remain heavy on financial expertise and relatively light in the digital department. For now, those who understand traditional banking mechanics often feel completely comfortable tackling the technology side of finance – but eventually, that will have to change.
“When you separate the ‘fin’ from the ‘tech’, most of the investment professionals in this space are fin-first, but frankly, we would all benefit from having more tech-first investors who really understand that side of the equation,” says EY’s Lloyd. “As a consequence, we’re unlikely to see big technology players emerge, and we’ll probably just see more traditional services operators with perhaps a more efficient infrastructure than the incumbents.”
CASE STUDY: NewAlpha – International transfers
Financial technology to date appears broad enough to support a fair number of narrowly specialized GPs, but the early movers do appear to be hedging their bets by diversifying across geographies.
The latest fund by UK-based Apis Partners, for example, encompasses both South Asia and Africa. Quona Capital and Accion International’s joint fintech program spans Asia, Africa and Latin America. Russia-based Finstar Financial Group targets across Asia, the US, Latin America, Europe and states of the former Soviet Union.
An uptick in Eurasian crossover in particular has added an interesting variable to this context. Recent activity in Hong Kong includes a government agreement to pursue a fintech partnership with London and local VC-backed e-wallet provider TNG Fintech teaming up with payments company Tranglo Europe. Meanwhile, Europe’s TransferWise raised $280 million for an expansion including India and Nepal.
“We are going to see more specialized funds in fintech, including insurance tech and data technology focused funds at different stages of development from early growth equity,” says Antoine Rolland, CEO at France-based NewAlpha Asset Management. “New Alpha therefore plans to launch a PE fund to invest in companies at later stages. The ability of traditional banks to retain clients is becoming more difficult, especially in Europe, where old business models are struggling to move into the digital world.”
NewAlpha’s historical focus on diversified seed funding has spurred a number of Asian forays, including the launch of a Singapore-based platform alongside Woori Investment & Securities. The firm established its fintech-only unit in 2015 and claims to be among the most active investors of its kind. Last year, it backed an early-stage round for TrackInsight, a European exchange traded fund analysis platform expanding into Asia.
European connections offer Asian fintech investors a theater of expansion for developed-market strategies without having to contend with the high valuations of the US. This play could prove especially relevant for lifestyle-oriented fintech sub-sectors related to changing consumer and personal banking behavior patterns.
The decision by NewAlpha to double down on these fields highlights an increasingly competitive environment for up-market fintech as well as a sense that migrating start-ups remain some of the more promising candidates for sparking industry disruption through bleeding-edge technologies. The firm sees potential in financial applications of artificial intelligence, robo-advisors and blockchain – areas where continental Europe could prove a key playground for global developers.
“Fintech is not just a fashion trend – it’s a real issue and we see real value in the companies we’re analyzing and investing,” Rolland says. “Since the last election in France, there has been a major drive to make the country more attractive for investors and for entrepreneurs. These changes will support the development of innovation and particularly fintech at the time when the UK is facing many issues due to Brexit.”