Secular Growth Stands Out as Earnings Climate Cools
Jennison Associates’ Mark Baribeau, CFA, shares why the changing growth landscape should benefit growth stocks and which secular trends are shaping the future.
Dec 8, 2022
The emerging markets fintech industry offers exposure to secular growth, but each country is regulated differently, requiring local insights to navigate risks.
Fintech companies use new technology to compete with traditional financial services, making their services simpler, faster, cheaper, and more convenient. Fintech represents a fast-growing area of the emerging markets, where many individuals and businesses have no access to a checking account or a credit card. Even in areas with financial services, many banks overcharge and underserve their customers while relying on old information technology architecture. Fintech companies have been quick to seize this opportunity.
Fintech’s potential for widespread adoption has a powerful example in China. Just a decade ago, consumers had few options except for state-run banks. Salaries were commonly distributed as stacks of paper bills; e-commerce companies fulfilled orders via bike delivery and took payments in cash. Seeing an opportunity, Chinese tech companies developed digital payment systems based on the internet technology, offering their hundreds of millions of users access to convenient, low cost, and secure financial services.
The result has been revolutionary. Encouraged by the need to seamlessly transact online payments, the new financial players leapfrogged developed market banking systems and were able to meet the financial needs of their customers through smartphones. The total transaction value of online payments in China rose more than 30 times between 2013 and 2020 to 295 trillion yuan, roughly equivalent to $44 trillion (Exhibit 1).1 Today, a strong majority of the Chinese internet population uses digital payments. The digitization spread from online payments to offline payments (through smartphones and QR codes) and then to virtually all financial services—making China effectively, in our view, the world’s first cashless economy. This is the fastest mass adoption of technology that we have witnessed in our 25 years of global growth investing.
Chinese regulators, however, have recently intervened in the local fintech industry, primarily to avoid a concentration of services in just a few firms. They have been especially focused on preventing “closed loop” financial systems in which a single company owns and manages end-to-end financial transactions. This new scrutiny has become an overhang for the Chinese tech industry, making it much more challenging for investors to confidently identify growth opportunities. This example illustrates both the explosive growth potential and some of the inherent risks for the fintech sector in emerging markets.
This growth potential is based, in part, on the fact that the companies running established e-commerce payment platforms are typically well positioned to expand into new business areas. Because they combine e-commerce with social media, they have compiled relatively sophisticated user profiles. Using technology based on artificial intelligence, these companies can mine customer data to sell additional financial services, including credit scoring, lending, and asset management.
We believe several emerging markets—especially Indonesia, India, and Brazil—are at an early stage of fintech development and have large underserved and unbanked populations, as well as SMEs (small and midsized enterprises) that can benefit substantially from improved access to financial services.
Each country is developing its fintech industry according to its needs and within its own particular regulatory framework. In some countries, such as India, regulators have allowed incumbent banks to develop and roll out fintech services. India has also introduced a Unified Payments Interface (UPI), which facilitates quick and cheap transfers of funds. These decisions have made the huge growth opportunity in Indian fintech likely to be less profitable for investors and highlight the need for careful bottom-up analysis of the companies in the emerging markets fintech space.
In other markets, such as Brazil and Indonesia, regulators have lowered the barriers to entry, thus encouraging tech companies to acquire bank licenses and offer fintech services. Brazil has also established a government-owned and government-run transaction system, PIX, which replaces a slow and expensive process with instantaneous and virtually free transactions. Some regulators have allowed fintech firms to offer a range of banking services. Indonesia, for example, permits channel partnering—where internet platforms are able to originate loans and offload the risk by selling the loan to a bank. This model can be very profitable but has a notorious reputation—off-balance-sheet mortgages almost brought down the global economy in 2008. Brazil’s regulators, in contrast, require that loans stay with the originator. However, the secular trend of replacing cash transactions with digital payments has a long growth runway in these markets.
Another area that appears especially ripe for fintech disruption across emerging markets is in credit creation. Significant parts of LatAm and ASEAN adult populations have no bank account and therefore little access to credit. Evaluating the financial resources provided by financial corporations to the private sector (as a percent of GDP) is one way to measure a population’s access to banking. In key Latin American markets, this figure remains below 75% compared to the more than 140% in developed markets such as the United States and the United Kingdom (Exhibit 2).2 In the ASEAN region, financial credit to the private sector can also be low. Moreover, most credit loans are held by large, incumbent banks, which have directed resources to their most profitable pool of consumers and businesses. The resulting financial system is characterized by low credit penetration and a concentration of outstanding credit with traditional financial institutions—an opportunity, in our view, for fintech companies who can meet this enormous need.
Investors, however, should be aware that these opportunities also carry risks. The importance of regulators cannot be overstated. Sudden, unexpected changes to regulations can negate long-term company plans, undermine competitive advantages, and make it virtually impossible for investors to model earnings and revenue growth.
Another risk is credit quality. Rapid growth in the fintech industry can result in lower-quality loans, which is a risk in emerging market economies as their credit markets are highly cyclical. With war, inflation, and economic uncertainty weighing on global investor sentiment, we are paying close attention to any evidence of credit deterioration. Where the fintech company is the offshoot of an e-commerce company, we would expect it to leverage the data and credit insights gleaned from the e-commerce platform in the form of superior credit quality compared to local banks that may not have this information.
These risks notwithstanding, we see fintech in emerging markets as a significant investment opportunity, offering exposure to three secular growth themes: technological innovation, financial services for the unbanked, and the strong growth of the middle class within the emerging markets. However, given the complexity of fintech investing and the multiple levels of systemic and idiosyncratic risk, we believe investors should combine a thorough understanding of the local regulatory and market environment with fundamental, bottom-up analysis of individual fintech companies.
1One yuan equals approximately 0.16 U.S. dollars and 0.13 euros (as of June 2020).
2Most recent data available.
Jennison Associates’ Mark Baribeau, CFA, shares why the changing growth landscape should benefit growth stocks and which secular trends are shaping the future.
Growth stocks are likely to outperform value stocks as growth becomes scarce with broader earnings growth retreating to below-trend levels.
Mark Baribeau, Head of Global Equity at Jennison Associates, discusses why slowing broader market earnings growth creates optimism for growth stocks in 2023.
Risks—Investing involves risks. Some investments are riskier than others. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investments in securities of growth companies may be especially volatile. Due to the recent global economic crisis that caused financial difficulties for many European Union countries, eurozone investments may be subject to volatility and liquidity issues. Illiquidity risk exists when particular investments are hard to sell; geographic concentration can result in more pronounced risks based upon economic conditions that impact one or more countries or regions more or less than other countries or regions; and derivative securities may carry market, credit, and liquidity risks. Emerging markets are countries that are beginning to emerge with increased consumer potential driven by rapid industrial expansion and economic growth. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas.
The views expressed herein are those of Jennison Associates LLC (“Jennison”) investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation. Clients seeking information regarding their particular investment needs should contact their financial professional.
Prudential Investment Management Services LLC is a Prudential Financial company and FINRA member firm. Jennison Associates and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. PGIM Quantitative Solutions is the primary business name of PGIM Quantitative Solutions LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2023 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM, and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.
For compliance use only 1065502-00001-00