Investing in the changing world of financial services

Amazon put the cat amongst the pigeons last week, when it told UK customers it would no longer accept Visa credit card payments from January next year due to high fees.

Visa’s chief executive, Al Kelly, was quick to respond saying, “I find it quite odd that they’re claiming they did this because of the high cost of acceptance of these in the UK. It’s just absolutely inaccurate.”

According to payments firm Bambora, Mastercard and Visa set nearly identical transactions fees in the UK. After Brexit was formalised earlier this year, both companies raised fees for digital credit card payments from 0.3% to 1.5% - so there is obviously more to the now-public spat.

Visa and Mastercard duopoly

Popular holdings among a number of global equity funds Visa and Mastercard have held an effective duopoly on global payments for decades. Maneesh Bajaj, manager of Brown Advisory US Flexible Equity, which is on the Chelsea Selection, told us recently: “We’d held Visa and Mastercard for more than a decade. They have built a powerful two-sided network and have very high margins and return on capital and, over the last decade, they have benefitted from the secular shift from cash to digital.

“Visa is a much larger company, and its revenues are roughly 50% more than MasterCard. And because of the scale Visa has, it has better operating margins than MasterCard. Visa also dominates the debit card market in the United States, and debit has been doing well in the current environment where consumers in the US are flush with cash.

“MasterCard, on the other hand, has been growing faster and has executed well in Europe. MasterCard was early in building a consulting business and provides additional value-added services to its customers.”

But increased fintech competition and geopolitical pressures are now threatening to weaken their influence – something Guy de Blonay, manager of Jupiter Financial Opportunities – another Chelsea Selection fund - is keeping an eye on.

Disruption in financial services

In fact, the financial services industry is facing a lot of disruption today. The rate of change was already fast, but the transformation in some areas has been accelerated by the pandemic. So, how can investors make the most of the financial revolution?

Current themes in the specialist Jupiter Financial Opportunities fund include digitalisation, payment solutions, data analytics, security and the Millennial/Gen Z wealth transfer.

“We continue to believe that we are seeing a structural – rather than transitory – shift in consumer behaviour and the acceleration in the pace of financial innovation in the wake of Covid-19,” manager Guy de Blonay said in a recent update.

“The financial services industry is still in the early stages of its digitalisation, and we believe this trend has much further to run. Digital and cashless payments have been core themes for us for some time, but beyond these areas, disruption is also impacting a much broader range of segments, including neo banks, InsureTech, PropTech, digital wealth management and cryptocurrencies.”

Cryptocurrencies and the “digitalisation of trust” is also a theme in the GAM Star Disruptive Growth fund, and manager Mark Hawtin told us more about this in his recent interview:

The more traditional area of banks, however, remains largely unpopular with equity managers. Chelsea senior research analyst, James Yardley, said: “Personally, I am not positive on banks - particularly those in the UK and Europe*. Regulation has severely reduced the amount they can leverage, which has impacted their profitability. 

“All their end markets are also under attack from increased competition. Credit cards are being disrupted by services such as Klarna, the mortgage market is hyper competitive as there is an excess of capital looking for a return and tech platforms are increasingly moving into the mortgage, insurance and asset management market. Legacy banks - which are forced to maintain a branch network - simply can't compete effectively with digital apps and platforms which don't have the same costs.”

But along with some of the insurers, banks are also helping make the world a safer place, as Liontrust Sustainable Future fund range team member, Mike Appleby, told us recently: “We need a healthy finance system if we're going to be able to make this transition to a more sustainable world,” he said.

“We’re looking for companies that are providing and lending capital to smaller businesses, or that are helping us spend money to make decarbonisation possible. Replacing a natural gas boiler with a heat pump or an alternative is not cheap. And it's critical that we have a finance system that's able to lend and allow people and the economy to make the investments that are required.“

Banks are also more popular with fixed income investors, however, as their balance sheets are in a much better place than they were ten years ago.

The managers of Chelsea Selection fund, GAM Star Credit Opportunities, find many of their best opportunities in the debt of banks and insurance companies, for example, as they believe the higher capital buffers enforced by regulators has made these businesses much safer. 

Artemis Corporate Bond, which is on the Chelsea Core Selection, also has more than 22%** invested in bank bonds, with more in other financial institutions.

*For full disclosure purposes, please note that James owns a few shares in Lloyds
**Source: Fund factsheet, 30 September 2021

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the fund managers and analysts, and do not constitute financial advice.

Published on 22/11/2021