Performance Comments
We have written for months about the headwind caused by not owning the Magnificent 7. That changed when Trump was elected in November last year, with the market broadening out of these seven market darlings, a trend that continued as the market rebounded in April. Volatility during the month remained extremely high on the individual stock level, with any signs of macro weakness or weakening guidance severely punished. On the back of rising uncertainty, risk premiums have been increasing globally, and there has been a continued shift out of the US into European and Asian markets, with Europe being a notable outperformer in April. In terms of sectors, Energy was the clear underperformer last month, with defensive sectors like Consumer Staples and Utilities, as well as cyclical sectors like Industrials, the outperformers.
Our FinTech portfolio navigated the market volatility quite well with an in-line performance. Swings on an individual stock level, however, were substantial, with payment companies on the wrong side of the market. Global Payments declined 22% as management made a complete U-turn by levering up the balance sheet to do a transformational deal by acquiring Worldpay. The market clearly didn’t appreciate this, as management promised an organic growth strategy that would reduce leverage not that long ago at its investor day. Another payment stock that suffered was darling Fiserv as SME growth engine Clover started to slow down. While at this point it is unclear whether it was driven by macro or company-specific factors, here as well, the market was not mild, pushing the stock down 16% for the month. On the bright side, emerging market payment names like StoneCo (+34%), Pagseguro (+32%) in Brazil or Lakala Payments (+23%) in China compensated for these two laggards. Again, global diversification in payments paid off. Volatility plays like flatexDEGIRO (+32%) also benefited from the market turmoil, thereby becoming our best contributor year-to-date with a 71% return. Earnings season is in full swing at the moment. We will provide a full update on the general direction of travel next month when most of our holdings have reported.
Last month, sector allocation contributed slightly positively and stock selection was negative, with an in-line overall performance. Performance relative to peers remains very strong for the year as well as inception-to-date. Given risk-on markets, Upcoming FinTech (+11.9%) performed best, while Established FinTech (-1.7%) and Enabling Technology (-2.5%) lagged. The stocks that contributed most to the Fund’s relative performance in April were StoneCo (+34%), flatexDEGIRO (+15%) and Mercadolibre (+20%). The worst performances came from Global Payments (-22%), Fiserv (-16%) and SSNC (-9%). The portfolio’s current positioning comprises 41% Established FinTech, 38% Enabling Technology and 21% Upcoming FinTech.
Market Review
The UST 10-year yield declined slightly in April to 4.15% but remains high given the increased sovereign risk for the US. The Bloomberg Commodity Index fell 5.1% in April, which was broad-based, as Energy as well as Metals dropped on fears of a macro slowdown. The VIX ended up at around 25 versus 22 in the previous month. That is very surprising given the risk-on environment and is a sign of ongoing market stress.
Thematic Insights
FinTech stocks provide natural hedges against rising inflation and a potential economic slowdown. Physical payment companies (payment processors and merchant acquirers that focus on physical stores as opposed to e-commerce) tend to benefit most from this natural hedge. Fundamentals for payment companies have been strong and the outlook remains positive. We do see a slowdown on the software side, which is why we have repositioned the portfolio away from the more expensive software names and towards the cheaper, quality payment companies. We also believe high-quality companies will benefit more than their loss-making, hyper-growth peers, as long as access to credit is declining and borrowing costs are rising. This is because quality companies can fund growth from their profits and cash reserves. Management can also make a substantial difference, and most high-quality companies have a team that has gone through several economic cycles and can navigate most market conditions.
C-suite level discussions are focused on digital strategy, which has moved from “nice to have” to “must have” to remain competitive and meet the needs of all stakeholders. Shareholder rewards have gone to digital leaders: clients expect services to be able to continue in the event of another lockdown, and staff expect the right tools to perform their jobs in a work-from-home environment.
Portfolio Activity
During April, we sold out of our remaining position in Lufax despite its attractive valuation, given macro uncertainty and ADR delisting risk. Whenever we can, we prefer direct exposure to the stock over ADR/GDR structures. Furthermore, we took profit in FlatexDEGIRO and LSE Group while adding to existing holdings Epam, Shift4 Payments and Tencent.
Outlook
The FinTech sector benefits from strong secular growth trends, such as the move away from physical cash, the digitalisation of financial services and the rising role of cybersecurity. The pandemic accelerated these trends through both push and pull forces – businesses have started to invest more in digital infrastructure so they can remain open during any future lockdowns, and consumers are demanding digital services for reasons of health, user experience or convenience.
Our investment process aims to select the highest-quality companies that can benefit from these trends to build a well-diversified portfolio. We believe the most important factors to watch are company-specific fundamentals such as revenue and earnings growth, return on equity (ROE), cash flow return on investment (CFROI) and balance sheet strength. We also monitor macroeconomic factors such as interest rates, inflation and growth. We diversify between Financial and Technology companies, aiming to create a stable, disciplined portfolio that can weather a multitude of market conditions. Within our FinTech mandate, our portfolio management style is best described as “quality growth at a reasonable price”.
Certain segments of the FinTech market are extremely interesting from a valuation perspective. Payments, for example, is a segment that has been sold by many generalists and is only held by a handful of specialist long-only funds. Despite the extremely good fundamentals, active managers and passives all accumulate positions around the Magnificent 7 stocks. As a result, the quality growth at a reasonable price strategy proliferates, particularly in the payments sub-sector where growth (both earnings and top-line) is higher than the market; quality is extremely high (this segment produces the top 10% of CFROIs globally) and valuations show a discount to the market.
Sincerely,
LO Funds–FinTech investment team
