By René Kerkhoff, fund manager of the DJE – Mittelstand & Innovation and analyst for the sectors technology, automotive and retail, and by Moritz Rehmann, fund manager of the GAMAX Junior and analyst for the sectors financial services and insurance.
The bill, please
Banks and insurance companies are at the forefront of the financial sector. However, current trends provide tailwind for others: Asset managers are benefiting from the low interest rate environment, and payment service providers are benefiting from digital change.
When investing in the financial sector, banks are often the first thing people think of. In the current low-interest environment, however, the trees for these do not grow into the sky. But there are also financial companies that are growing strongly and some of them are even benefiting significantly from low interest rates.
Asset managers can take advantage of low interest rate environment
The asset managers' investment universe can be divided most easily according to the asset classes to be invested. Two business models should be highlighted here: The first involves investing in equities or bonds of exchange-traded securities. The second category includes asset managers that invest in illiquid or "alternative assets". What both have in common is that they are favoured by the extreme negative interest rates currently present in many regions, as the pressure to find alternatives increases as the duration of the problem increases. This is not least because the average interest rates used in many models are formed on a lagging basis over multi-year time intervals, so that a low interest rate only slowly creeps into the portfolio or, as in the insurance industry, the opposite discounting of the liability. Demand for products that promise to help investors under earnings pressure is now correspondingly high.
Record inflows of funds for providers of alternative assets
The investment crisis is particularly evident in the alternative asset management segment, with strong market participants in the US and Switzerland and, most recently, another from Northern Europe, which has been particularly pronounced in the form of record net inflows. The US market leader was able to raise more than 150 billion US dollars of capital in the past twelve months. This is more than significant, especially when compared to the funds managed in this segment to date (USA: approx. 4.7 trillion). The flipside of the coin is the pressure with which these funds must be invested. This is all the more demanding in a market focused on illiquid investments. In the course of this investment pressure, the expected return also decreases - from historically around 10 percent to more likely 6 percent in the future - although it remains very attractive relative to the return of the regular interest rate markets.
For the manager of the funds, the term of the products is particularly attractive: with a plannable time frame of around ten years, this results in a predictable income stream from fees with supplementary performance-related components. Furthermore, there is a trend, particularly in the closed-end real estate funds segment, towards swapping the classic term component for an unlimited concept. In combination with the extension of the term and higher shares of recurring income, this would make the products even more attractive for the manager.
So far, the investment universe of alternative investments has been accessible primarily to institutional investors. In the US market, however, work is currently underway to launch products that would enable a wider community of investors to invest. The very good momentum of the sector is also underlined by the recent, very successful IPO of a house from the private equity segment in Northern Europe. The environment of "investment distress" caused by low interest rates will continue for the foreseeable future, and the prospects for the alternative asset manager segment are correspondingly positive.
Equities and bonds: two trends drive asset managers
The segment of asset managers for equities and bonds traded on markets is primarily dominated by two thematic areas. Firstly, the trend towards products with a passive approach and low costs. This segment of ETF providers thus grew disproportionately and in the US market alone at an annual growth rate of almost 18 percent over the last nine years. But a tough price war has long since begun here. It has led to funds with a fee of zero basis points, especially for common underlying indices such as the S&P 500. Profits here are achieved in a different way with the equity holdings held. In this respect, the pressure on margins for standard products is clearly noticeable - and this must be countered with more innovation, for example with smart beta products.
The second important topic is the expected growth dynamics in Asia in the coming years. According to PWC's forecasts, assets under management there are set to almost double to 29.6 trillion. Economies of scale, regional focus and innovation are the key to success for asset managers in this segment. It is precisely the high relevance of economies of scale that leads to active consolidation, especially in the still relatively fragmented European market. Overall, however, the market is structurally highly attractive for the long-term winners in view of the expected market growth rates.
Payment service providers still on the winning side
The world of cashless payments is unimaginable without payment service providers (PSPs): Payment service providers accept electronic payment transactions between merchants and customers, authenticate them and process the transaction. Since the PSP can connect to various payment and card networks as well as acquiring banks, the merchant becomes less dependent on financial institutions when managing transactions and can process transactions more transparently. However, the main advantages for the merchant result from the various fraud prevention measures taken by payment service providers. They protect the merchant and the customer from fraudulent transactions and generally assume the entire risk and liability during processing. These advantages provide a certain amount of consumer confidence and increase the acceptance of cashless transactions in both stationary retail and online shopping.
Business is booming, driven by the emerging markets
To support merchants vertically throughout the entire payment process, many payment service providers also offer additional software solutions. These can help to record and analyze the complete payment flows. However, a payment service provider earns the largest share of the transactions: Although the fees are regulated relatively strictly, they vary depending on the payment method, buyer or product type. Coupled with high structural growth rates due to the trend towards cashless payments, payment service providers can achieve relatively high margins.
Business is booming. Consumers around the world are paying less and less in cash, which is causing the volume of card and online payments to rise rapidly. The management consultancy McKinsey forecasts that the transaction volumes in payment transactions worldwide will skyrocket from just under USD 1.9 trillion a year at present to a good USD 2.9 trillion in 2022. One growth driver here is the emerging markets, where more and more consumers are gaining access to banking and electronic payment services.
Germany still has catch-up potential for cashless payments
Although half of German customers already make cashless payments, they are still cash enthusiasts by international standards. When it comes to the number of cashless payments, Germany ranks 15th in Europe with 212 transactions per capita per year. So there is still plenty of room for improvement. For comparison: In Norway, the number of cashless payments is more than twice as high, at around 545 payments per capita per year. In the USA, credit card sales per capita are on average more than seven times higher than in Germany.
However, a clear trend towards cashless payments can also be seen in this country. According to the industry association Bitkom, 44 percent of Germans would be prepared to do without cash altogether. This trend is also driven by the success of mobile payments in Germany. Mobile payment has got off to a good start in recent years and more and more merchants are offering contactless payment.
Conclusion: Consolidation in the payment sector offers investment opportunities
In 2019, the trend towards consolidation due to growing competition in the payment sector continued, enabling acquisitions in the double-digit billions in the USA alone. So far, however, banks have not been affected by the new development in the payment services industry. They are no longer able to reflect the innovative and highly technical developments and are increasingly leaving the field to the large tech groups. They are becoming increasingly interested in digital payment transactions and are investing large sums in research and development to get a piece of the growing pie. The structural trend towards more cashless payments thus offers investors interesting investment opportunities in promising shares of the high-yield, digitally networked payment service providers.
Note: All information published is for your information only and does not constitute investment advice or other recommendation. Long-term experience and awards do not guarantee investment success. Securities are subject to market-related price fluctuations which may not be compensated for by the active management of the asset manager or investment advisor. This information cannot replace a consultation. All information has been provided with care and to the best of our knowledge at the time of preparation. Despite all due care, the data may have changed in the meantime. Further information on opportunities and risks can be found on the website www.dje.de. The sales prospectus and further information are available free of charge in German from DJE Investment S.A. or at www.dje.de The fund management company is DJE Investment S.A. DJE Kapital AG is the distribution agent.