The investment case for financial-sector innovation

Exposure to secular or disruptive themes can provide investors with significant diversification from risk factors

The investment case for financial-sector innovation

The traditional financial sector has been a mainstay allocation in many investors’ portfolios, but the rapid rise of technology has created a new space for them to consider.

In a recent commentary, Hamilton ETFs argued that technology has given rise to a new category of financial companies that not only promises exposure to superior returns on equity and higher earnings-per-share growth, but also diversification from the interest-rate risk and credit risk that beleaguers most Canadian financial firms.

Highlighting its Hamilton Financials Innovation ETF, the firm pointed to a few key categories that are set to benefit from secular themes driving global financial-sector innovation.

“The COVID-19 pandemic has accelerated a multi-decade, structural shift away from cash transactions,” the firm said, noting a host of potential beneficiaries including card networks, merchant acquirers, processors, mobile payments (in-store), and payment gateways. “According to a U.S. Census Bureau report, the pandemic significantly boosted eCommerce sales … resulting in a surge in user adoption, volume, and revenue growth in digital payments.”

Technological advancement has also helped capital market-related businesses, which have seized on regulatory and policy reforms put in place after the global financial crisis. With a wide array of asset classes now trading electronically, financial companies have taken on significant M&A activity, which includes ancillary businesses. That has led to diversified business models that often benefit from greater market turbulence.

“[T]he multi-year shift from higher cost mutual funds to lower fee ETFs (including active to passive) has been a powerful trend, creating structural winners (and losers) in investment management,” the firm said, explaining how innovation has been a tailwind for ETF managers. Online brokers, meanwhile, have seen material success from the secular shift to self-directed investing as well as their efforts to expand into related activities.

Other segments of fintech, Hamilton ETFs said, are not clear candidates for portfolio inclusion. Aside from being Davids to traditional bank Goliaths, standalone internet banks face structural challenges from risk management, access to funding, and regulatory capital. And while robo-advisors are building healthy capital from very high growth, the low-fee structures they offer make reaching scale a do-or-die priority.

“Other segments/themes like blockchain and insurtech are too disparate, early stage and/or too speculative in our view for inclusion at this time,” the firm said.


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