Most companies will inevitably have to adapt to changes at some point in their life as customer preferences evolve and technology opens up new ways of operating. The banking sector is now facing this situation and this is why ‘fintech’ (or financial technology) has become such a buzzword.

Banks with hundreds of years of history are finding an ever-growing number of smaller businesses snapping at their heels trying to disrupt the sector. Many of the incumbents cannot change fast as they are dependent on legacy IT systems and implementing new, modern innovative technology is not as simple as ‘plug and play’.

Most of the large London-listed banks reported solid earnings growth in their latest quarterly figures. Why worry, you might think? The rise of fintech is heavily linked to changing consumer habits, so while the big names like Lloyds (LLOY) may look strong today, they are facing a more difficult future. That explains why Lloyds is investing £3bn in its technology and people.

One could argue big banks have plenty of money to invest in new technology. The big problem lies with the costs of dealing with their legacy IT systems and having a large workforce. The new wave of fintech companies are more nimble which gives them an advantage.

Some fintech firms are already worth a considerable amount of money. For example, Monzo has more than 1m current account customers and is now worth £1bn, a near four-fold increase in valuation in a single year. Revolut is valued at $1.7bn (£1.3bn).

DIFFICULT TO INVEST IN FINTECH

Investing in the fintech space is difficult as most of the better-known names tend to be backed by venture capital and aren’t on the stock market (yet).

Augmentum Fintech (AUGM) is circumventing this problem with a portfolio of fintech companies available to retail investors via its investment trust.

‘We will see brands that don’t exist today become future household names in financial services worth billions of pounds. Our job is to identify some of the future winners,’ says its chief executive Tim Levene.

Augmentum’s seed portfolio includes stakes in stockbroker Interactive Investor and P2P lending company Zopa. These are more mature businesses than it intends to back in the future and their presence just helps to sell the investment trust’s story until it is better known.

Levene has since been snapping up stakes in lesser known names including Tide, an SME challenger bank. He also sees opportunities as tech firms start to disrupt the insurance sector, although he notes this area is less mature than fintech-related consumer banking and foreign exchange.

Names like Monzo wouldn’t fit the bill for Augmentum as the trust wants to invest at an earlier stage, plus Levene says digital banks may not be good investments even if they become successful businesses. ‘They require significant capital to reach critical mass so there is a dilution risk for investors.’

A NEED FOR PATIENCE

Augmentum really needs to increase scale before it becomes of any interest as a true fintech fund. Diversification is important given the competitive nature of this space and it currently has a mere 11 holdings.

Investors will also need to be very patient as it is hard to predict when unquoted companies will have a valuation uplift – thus Augmentum’s own share price performance may also not follow a smooth path. (DC)

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