Fintech is here. In fact, it’s everywhere. This marriage of financial services and technology aims to make financial transactions more time- and cost-efficient for both providers and consumers, and the rollout of fintech apps, tools and platforms has become so prevalent that it’s hard to imagine how any financial services company can exist without having a digital offering.
That poses the following question: What exactly does “fintech” mean from an investment perspective? Is this really a distinct investment opportunity, or just a fancy label that puts a cutting-edge spin on traditional financial services?
The consulting firm PwC says fintech can refer to start-ups, technology companies or legacy providers. “The lines are blurring, and it’s getting harder to know where technology ends and financial services begin,” it said in a report from 2016.
But much has happened during the past four years to help crystallize the essence of fintech.
“Those lines have been blurred for some time, but I think that’s not the case anymore, because over the past few years we’ve learned how to identify fintech companies by looking at what they’re doing in the marketplace,” said Pedro Palandrani, thematic tech analyst at Global X Funds, which debuted the Global X FinTech ETF (FINX) in 2016.
Fintech’s raison d'être, he offered, can be synthesized in a single sentence. “For us, it’s as simple as the application of disruptive technologies to traditional financial services providers.”
Palandrani elaborated by adding that fintech can offer cost efficiencies and enhanced customer service for consumers while enlarging the customer base and creating new revenue opportunities for companies.
He said the Global X FinTech ETF covers the entire fintech ecosystem via six different segments: peer-to-peer lending; mobile payments; crowdfunding; personal finance software/automated wealth management trading platforms; blockchain and alternative currencies; and enterprise solutions.
The last segment includes companies that provide behind-the-scenes technology enabling banks, insurance companies and other financial services organizations to improve their operations and beef up their digitized offerings to consumers. An example of an enterprise-level enabler is Guidewire Software Inc. and its cloud-based platform providing analytics and artificial intelligence-based tools for property and casualty insurance carriers.
Guidewire is a holding in the FINX fund, but the legacy financial services companies it serves aren’t. And neither are companies such as Apple or Amazon.com, which theoretically can be viewed as fintech players.
“Given that we’ve identified those six segments, we’re able to target the companies that are leaders in each segment and provide access to pure-play fintech companies,” Palandrani said, adding that “pure-play” encompasses companies that generate a significant portion of their revenue from one of those six segments.
FINX is a sizable fund with nearly $905 million in assets. It tracks the Indxx Global FinTech Thematic Index, and charges an expense ratio of 0.68%.
It is one of two U.S.-listed ETFs that cover the broad fintech universe (there are two ETFs focused on mobile/digital payments). The other broad-based fund is the ARK Fintech Innovation ETF (ARKF), an actively managed fund that began trading in early 2019.
Fund sponsor ARK Invest says it has identified 14 transformative technologies—grouped within five transformative innovation platforms—it believes will fundamentally change the world within 10 years or so. And fintech is one of those transformative technologies.
As ARK describes it, fintech companies focus “on changing the way the financial sector works, removing friction, and increasing accessibility to financial products and services.” The ARKF fund invests in companies involved in mobile payments, digital wallets, peer-to-peer lending, blockchain technology and what it calls financial risk transformation.
“These innovations should revolutionize the financial industry, impacting every sector of the global economy,” says ARKF’s fund literature.
In an interview a few months back, ARK client portfolio manager Renato Leggi pointed to fossil fuel-based energy, big pharma and banks as industries that could be disrupted by technology. For banks, that means fintech.
Both the ARK and Global X fintech funds count payment company Square Inc. as their top holding, and other repeat holdings among the funds’ respective top 10 positions include Dutch payment company Adyen NV and PayPal Holdings Inc.
FINX contains 33 stocks versus 49 for ARKF, but there are only seven overlapping holdings between them, according to ETF Research Center. That should provide a dose of differentiation between them, as should their different methodologies—to repeat, FINX is passive and ARKF is passive.
ARKF, the more expensive of the two with an expense ratio of 0.75%, had gained 96.5% year to date (as of December 9) while FINX rose 42.9%.
Is It A Tech Or Finance Play?
Morningstar fits both ETFs into its U.S. technology total return category. So is the fintech category a play on technology or financial services?
If it’s the former, an apt comparison could be the technology bellwether fund Invesco QQQ Trust (QQQ), which charges an expense ratio of 0.20% and has a year-to-date return of 42.5%.
When looking at it from a financial services perspective, both FINX and ARKF have smoked the two largest broad-based financial sector ETFs. The Financial Select Sector SPDR ETF (XLF), with fees of 0.13%, is down 3% this year, while the Vanguard Financials ETF (VFH), which charges 0.10%, is down 4.8%.
On a three-year annualized basis, FINX’s 26.3% return is slightly better than QQQ’s 25.9% return, and miles ahead of the low-single-digit returns from XLF and VFH.
But do such comparisons even matter? Palandrani posited that thematic investing, including fintech, transcends traditional classifications like the 11 economic sectors within the S&P 500.
“Many of these themes are actually disrupting these traditional sectors,” he said. “Fintech is mostly classified as information technology companies that apply disruptive technologies that are identified to financial services and banking.
“But for us, that doesn’t necessarily mean that fintech should be considered an exposure or allocation to the information technology portion of an investor portfolio,” he added. “We think investors should look at fintech from the lens of disruption, and if they have an allocation toward financial services, we believe that in order to capture the future of the financial services sector they should have exposure to fintech-related companies.”
But getting back to the FINX versus ARKF comparison, does the latter’s significant outperformance during the past year indicate that active management is the way to go with fintech funds?
Naturally, Palandrani begs to differ. He views both passive and active as complementary strategies in the fintech space.
“For investors, it’s important to get exposure to a passive strategy because we may not know who the ultimate winners will be—in any emerging technology there will be winners and losers,” he said. “So a passive strategy could be the best vehicle to get exposure to a theme where you’re getting the winners, and the losers could become a smaller portion of your portfolio.”