equities
Global FinTech: trends to watch in 2024
Beating the broader market was challenging for many active strategies in 2023, including our Global FinTech theme. However, Global FinTech has had the highest absolute return among its relevant peer group since our inception in 2020. We attribute the longer-term outperformance to our strict adherence to seeking quality growth at a reasonable price. Thematic purity is also hugely important to us, meaning we do not invest in the ‘Magnificent 7’.
In 2024, we look forward to a broadening of the market toward our fundamentally sound and attractively valued portfolio of companies. We discuss trends to watch for in 2024 – including AI opportunities in financial services and increasing M&A – as well as our macro outlook and portfolio positioning.
Please click on the buttons below to read our outlook.
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An appraisal of 2023
Our Global FinTech strategy has achieved a 14.45% absolute return this year, driven by the solid fundamentals of our high-quality portfolio.1 The holdings delivered another year of strong revenue and double-digit earnings growth at very high and sustainable CFROIs (Cash Flow Return on Investment).
Beating the MSCI ACWI index, however, has been challenging for many active strategies this year, including the FinTech theme. The MSCI ACWI’s gains stemmed largely from a handful of US mega-caps – the ‘Magnificent 7’ tech stocks. Not owning those names (in our case because of purity concerns) has hindered relative performance.
Since inception, however, the strategy’s risk-adjusted return remains best-in-class within the fintech peer group. When compared with similar strategies, Global FinTech has the highest absolute return and the lowest volatility since our launch on 7 April 2020. We believe this results from our strict adherence to seeking quality growth at a reasonable price. We do not claim to be able to beat the market or peers every year, but we are convinced that our approach prevails over the long run.
In this outlook, we will first review 2023 markets to see what contributed to performance and what detracted. Then we discuss trends and our macro outlook for 2024, concluding with our portfolio positioning.
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Market overview
Narrow leadership
As the table below shows, quality has been the only winning style in the past year given the macro and geopolitical uncertainties. All of the others – e.g., value, momentum, low volatility – lagged the overall market.
Comparison of style performance in USD in 2023
Source: www.msci.com
Market leadership has been even more concentrated. In fact, the majority of the market’s return in 2023 can be attributed to just a handful of mega-cap tech companies – Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla2 (the Magnificent 7). The chart below shows the outperformance – almost 100 percentage points – for this basket of tech heavyweights, with Nvidia outperforming by more than 200 percentage points.
While this is not our field of expertise, we believe most of this extreme divergence from the broader market is linked to Generative AI hype. From a risk point of view, as documented in our whitepaper AI in financial services (Sept 2023), we now see valuations of AI stocks approaching 2000 bubble territory.
FIG 1. Performance of Magnificent 7/Nvidia vs. broader market
Source: Bloomberg
Comparing MSCI ACWI with the equal weighted and midcap indices also reveals the dominance of the Magnificent 7, with the MSCI ACWI market cap weighted outperforming the equally weighted index by double-digit percentage points for the year.
FIG 2. Comparison of MSCI ACWI with equal-weighted and midcap indices
Source: Bloomberg
Purely fintech
Our FinTech strategy remains overweight quality and growth at a reasonable price because of our strict investment process. Thematic purity is of the utmost importance, however, because we want to offer clients the strongest way to benefit from long-term trends driving the digitalisation of the financial sector. We therefore do not invest in any of the Magnificent 7 or other non-fintech, pure tech platforms. Purity to us means at least 20% exposure to finance, with finance being the driver of stock market returns.
This high level of purity and resulting 40% underweight in the USD 50 billion-plus market cap range has detracted 15 percentage points from our performance relative to MSCI ACWI this year, while stock selection, corrected for this market cap effect, has been strongly positive. For 2024, we look forward to a broadening of the market away from this handful of highly valued, mega-cap companies and toward our fundamentally sound and much more attractively valued fintech companies.
The next table provides an overview of our investment process, with a focus on long-term trends, purity, quality and sustainable business models combined in a balanced, diversified and high-conviction portfolio.
From fintech trends to a high conviction portfolio
For illustrative purposes only.
Strong premiums
While global M&A activity has dropped by 25% in the past year because of macro uncertainties, there is a long list of attractively valued fintech companies that have been acquired or are rumored to be. The targets have spanned the fintech universe – including payments and software companies – at strong premiums of an average 41% to undistorted prices.
All payment deals (EVO Payments, Paya, Network International2) were of a strategic nature given the strong rationale for synergies from economies of scale and better in-market pricing. Most private equity deals were focused on the software companies given the highly recurring nature of their revenues and cashflows. We benefited from three of the deals listed below: Network International and Duck Creek Technologies from the target side and EVO Payments from the acquirer side. With current extremely attractive valuations and stabilising interest rates, we expect M&A to remain a theme, and performance driver, in the new year.
Recent fintech M&A deals2
Source: Bloomberg, LOIM, as of 30.11.23. Past performance is not an indicator of future results.
Valuations disconnectBesides offering the purest possible way to benefit from long-term fintech trends, we will always be exposed to quality growth companies. Furthermore, the investment’s risk profile should be low, with future economic profits not yet discounted in current market prices, low dependency on external financing and a solid sustainability profile. We search for companies with a sustainable competitive advantage, above average growth characteristics and high profitability. We prefer our companies to reinvest their operating cash flows into growth opportunities to increase economic profits through time. As the graph below shows, the portfolio is 30% overweight quality growth companies.
FIG 3. FinTech portfolio segment exposures
Source: Credit Suisse HOLT, November 2023. Holdings and/or allocations are subject to change.
From the latest characteristics overview, we can conclude that the portfolio is showing an above average level of profitability and cash flow while being internally financed. Both the revenue and earnings growth are more structural and significantly higher relative to the market, while valuations are disconnected from these solid underlying fundamentals. Quite uniquely, given the above average growth and quality characteristics, both current and next year’s earnings multiples are at a significant discount to the market.
Financial metrics
CAPITAL EFFICIENCY (trailing 12m) 4
Fund2
Index3
Return on equity
14.9%
14.2%
Maintenance FCF
20.7%
13.2%
External Financing
-5.6%
-2.9%
GROWTH
(CAGR 2Y)5
Fund2
Index3
EPS growth CAGR 2Y
19.5%
10.5%
Sales growth CAGR 2Y
10.0%
4.7%
VALUATION1
Fund2
Index3
Dividend yield
1.1%
2.1%
Forward PE 1Y
15.6x
16.7x
Forward PE 2Y
14.1x
15.0x
Price to Book
2.5x
2.8x
OTHER METRICS
Fund2
Index3
Active Share
0.97
Weighted average market cap (USD bn)
52.1
472.5
Source: LOIM, as at 30 November 2023. Past performance is not a guarantee of future results; metrics subject to change. Portfolio composition represent a portfolio construction goal. It is not representative of actual, complete nor accurate past, present or future portfolio holdings. For illustrative purposes only.
1 Harmonic average.
2 Fund: LO Funds-Global FinTech.
3 Index: MSCI World ACWI USD ND. Index methodology.
4 Weighted average excluding outliers. Use of capital employed in case of negative equity.
5 Weighted average excluding outliers.Our disciplined approach has resulted in best-in-class performance among our fintech peer group since inception, with below average volatility. We cannot promise the best performance every year (e.g., we missed out on the hyper-growth trend in 2020). However, it is our strong conviction that in the long-run, investing in quality growth companies with expected cash generation that is not priced in will result in superior risk-adjusted returns for our investors.
FIG 4. Global FinTech peer group comparison
Source: LOIM. Data as of 29.9.23. Past performance is not an indicator of future results.
FIG 5. Volatility comparison with peer group
Source: Lombard Odier, as of 31.10.23
We are convinced that the investment environment has fundamentally changed, given the return of inflation and the end of ultra-loose monetary policies worldwide that started after the Great Financial Crisis in 2008. Having a clearly defined, sustainable and profitable business model with a sound balance sheet will be key to outperformance. The easy times of attracting financing based on fantasy TAM presentations are definitely behind us. Applying a thorough valuation framework across the portfolio will also make a comeback as competition from alternative asset classes (e.g., high-quality fixed income or private assets) increases. The combination of the earnings yield and growth outlook has to be superior to those.
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AI and other key trends
AI in finance
Although the fintech landscape is highly dynamic and subject to rapid changes, we expect a key trend next year to be AI opportunities in financial services. As discussed in our AI whitepaper, we stress the need to be aware of the hype around generative AI and to focus on real use cases. Generative AI is unlikely to be disruptive to the financial sector, and instead will be used to achieve efficiency gains. These generative AI models are known for their tendency to ‘hallucinate’, which drastically limits use in applications that require fact-based outcomes in a heavily regulated sector like financial services. To us, AI is about technology that has been developed and improved over decades and is now at a stage of real execution given the availability of greater computing power and high-quality datasets.
AI within financial services must be viewed very differently from other sectors. It involves a difficult interaction between objective and subjective inputs and outputs, while regulatory requirements need to be incorporated too. The entire AI market, including services and hardware, is expected to reach USD 900 billion by 2026, which would imply a CAGR of 19%.3 Financial institutions represent 20% to 25% of this total market. In financial services, AI is most likely to be used in risk assessment, fraud prevention, marketing and customer services.
An important area of efficiency improvement is in R&D, with 20-40% lower costs already being achieved by industry leading companies like PayPal2,4, which could be exemplary for the industry.
AI applications in finance
Source: OECD, 2021. For illustrative purposes only.
More M&A
As mentioned, we think M&A activity will continue next year given the disconnect between fundamentals and valuations. Searching for incremental growth and synergies by consolidating within the payment space is sure to remain a recurring theme. Furthermore, we expect private equity to remain active given the abundance of M&A opportunities. With many private equity listings trading far below IPO levels, making secondary placements difficult, we expect much more public-to-private transactions in this space. While nice for short-term returns, for us M&A is never the starting point for taking a position in a company, but always the icing on the cake.
Other key trends to watch in 2024
- Broader adoption of Central Bank Digital Currencies (CBDCs). CBDCs make sense from a financial inclusion point of view in underbanked markets; however, we remain cautious on broad-based implementation in the developed world given ongoing doubts from all parties involved. Still, more countries will move from the research phase to preparation and implementation next year, which is sure to keep the discussion alive. As noted in our whitepaper China leading the move to a digital currency (Sept 2020), we see the biggest steps towards a digital currency in China, followed by other emerging markets. More efficient and cost-effective cross border payments remain a large opportunity.
- Real-time payments in fintech, or the ability to make nearly instant payments. Opportunities stem from offering better, faster and more convenient financial services, while there are risks from potential disruption to existing fintech offerings or payment rails. PIX in Brazil or UPI in India are examples of the rapid growth potential of alternative payments.
- Asset tokenisation, or the representation of real assets as digital tokens on a blockchain. With the growing demand for alternative and private assets, we expect the asset tokenisation trend to accelerate next year as it helps to democratise investment in illiquid assets for the broad audience. We describe the benefits in more detail In our whitepaper Tokenization: Revolution or Evolution (July 2020).
- Cybersecurity. With the digitalisation of society, especially combined with the rapid adoption of AI, more bad actors are likely to emerge. Ensuring robust protection of sensitive financial data is key to expanding fintech offerings. Both as a trend to invest in and from a governance perspective for our investments, we think an approach involving the integration of cybersecurity will be even more essential. We describe our unique approach in more detail in Cybersecurity: a neglected risk in a digitalized world (July 2022).
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Macro outlook 2024 5
While recessionary risks remain, we expect that the US will avoid a severe downturn in 2024. The absence of credit excess among companies or households in the run-up to the rate-rising cycle has helped protect growth and shield labor markets. The global economy should benefit from rate cuts in the second half. Peaking yields and a soft economic landing should help support investor risk appetite, corporate balance sheets and equity markets.
Of course, we do not underestimate the risks ahead: from geopolitical tensions and conflicts to volatile energy markets, US-China competition and a high-stakes US presidential election. The impact of restrictive credit conditions must also be carefully monitored.
Such opportunities and challenges highlight the importance of a rigorous investment approach, active management and portfolio diversification.
Which microforce dominates? Scenario analysis 2024
Source: Lombard Odier. For illustrative purposes only.
We prefer US over European markets, where both inflation and growth have slowed sharply and where the full effects of monetary tightening have yet to be felt. The transatlantic gap that opened during the pandemic owing to the outperformance of the US economy has widened further.
FIG 6. Evolution of GDP trajectories
Source: US Bureau of Economic Analysis, Eurostat, Lombard Odier calculations
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Portfolio positioning
For the Global FinTech strategy, we have identified more than 300 companies that benefit from the digitalisation of the financial sector. A snapshot of this universe is below. We perform a quality overlay to select the best business models and financial track records.
FinTech universe of opportunities
300+ companies / EUR 16bn average market capSource: Lombard Odier, November 2023. Payments and efficiency providers represent one third of the universe. The remaining blocks together represent the final third of the universe. For illustrative purposes only. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document. Holdings and/or allocations are subject to change.
Our portfolio selects only the best quality stocks from the universe above. At the moment, the portfolio is tilted towards payments (35% of the portfolio) and efficiency providers (37%), with the remainder spread over the blocks in the middle of the table.
Payment companies
We find payments very attractively valued, but we are selective. We currently hold 20 payment names, which implies we have an average payment company position of 1.75%. In our top holdings, several payment companies can be found at maximum model weights (we have 1%, 2% and 4% portfolio model weights). A combination of strong fundamentals, cheap valuations and the macro outlook puts this segment in a good position to generate high returns in the years ahead.
Payment companies have had a difficult time, in terms of valuation, for the past 24 months. Rising interest rates, and fears of hard landings and the impact on future earnings estimates led to severe multiple contractions. However, the companies we invest in showed quarter after quarter that they were able to beat expectations and continue to grow revenues and earnings. We believe it is fair to say that the market has been too harsh on these names. We do not know when multiples will revert back to normalised levels for these companies, which grow 10%+ topline and 12-15% earnings. We do know that if they continue to perform as they did in the past, the expected return profile looks very attractive.
Efficiency providers, innovative solutions
The efficiency providers (B2B) are a bit more expensive than payments. However, strong and steady CFROI profiles make up for that valuation difference. We do not expect an extremely benign macro environment for software, but we believe pipelines will continue to be filled and the year ahead will be business as usual for most software providers. This would allow these names to grow into their multiples and show their sensitivity to the cycle. If multiples remain at these levels, this segment will also perform well.
The rest of the portfolio is tilted towards innovative solutions (such as within cybersecurity and disruptive technologies). We did not chase hype in these segments and only invest in companies with good fundamentals. These add beta to the portfolio and provide it with extra ingredients to outperform the market. Most of these companies are in their growth stage, though, so from a risk perspective we prefer to keep the model weights limited and diversify across the segments.
Room for upside surprises
Within the quality framework of our investment process, we have constructed a balanced high-conviction portfolio of 40-60 companies, which we can subdivide in three categories:
Holdings and/or allocations are subject to change.
Whereas the exposure to Upcoming FinTech (15%) has remained stable during 2023, we have expanded our position in Established FinTech (44%) at the expense of Enabling Technology (41%). After years of de-rating due to disruption or economic slowdown fears, valuations for payment companies have become too attractive to ignore, in our view.
The opposite is the case for Enabling Technology, with valuations sometimes leaving no room for error. We have a barbell investment approach, diversifying across sectors (financials and technology), countries (a truly global strategy) and market capitalisation (avoiding the mega-caps and overweight mid- to large-caps).
In conclusion, we think current attractive valuations combined with a renewed focus on profitability and abundant AI opportunities – along with inflation and interest rates becoming tailwinds – leaves a lot of room in 2024 for upside surprises.
sources.
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The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.
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Bloomberg: “BLOOMBERG®” and the Bloomberg indices listed herein (the “Indices”) are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the Indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by the distributor hereof (the “Licensee”). Bloomberg is not affiliated with Licensee, and Bloomberg does not approve, endorse, review, or recommend the financial products named herein (the “Products”). Bloomberg does not guarantee the timeliness, accuracy, or completeness of any data or information relating to the Products.
Morningstar: Morningstar Category: Morningstar assigns ratings based on comparisons of all funds within a specific Morningstar Category, rather than all funds in a broad asset class. The information contained herein is proprietary to Morningstar and/or its providers, may not be copied or distributed and is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are not responsible for any damages or losses arising from any use of this information. For more information about the Morningstar Category:
https://www.morningstar.com/content/dam/marketing/shared/research/methodology/771945_Morningstar_Rating_for_Funds_Methodology.pdf and http://www.morningstar.com
Morningstar stars: The star rating is based on risk-adjusted performance. A fund must have a record of more than three years. Star ratings are graded on a curve: the top 10% of funds receive five stars, the next 22.5% receive four stars, the middle 35% receive three stars, the next 22.5% receive two stars and the bottom 10% get one star.
A rating alone is an insufficient basis for an investment decision. A rating is drawn for illustration purposes only and is subject to change. It is not a recommendation to invest in the Fund. It does not predict future performance of the Fund. There is no guarantee that the investment objective of the Fund will be reached.
For details regarding the star rating method:
https://www.morningstar.com/content/dam/marketing/shared/research/methodology/771945_Morningstar_Rating_for_Funds_Methodology.pdf and www.morningstar.com. Morningstar is not responsible for any damages or losses arising from any use of this information.
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