Silvercrest
Global FinTech

Silvercrest–Global FinTech

Performance Comments

We have written for months about the headwind caused by not owning the Mag7. That story changed when Trump was elected in November, with the market broadening out of these seven market darlings. March was another such month, but it feels more structural this time. On the back of rising uncertainty, risk premiums have been increasing globally, and there has been a shift out of US equity into European and Asian markets. The end result of all this volatility is that high-multiple stocks corrected and the Mag7 names have become funding for a shift to other geographies. There are two effects at work here – one is temporary and the other is more structural. The first effect is that uncertainty is starting to affect decision-making for businesses, putting big projects on hold. This has a trickle-down effect and, ultimately, results in lower economic growth. The reason why this might be a temporary effect is that we saw the Trump administration focus on tariffs and costs first, only to use those proceeds at a later stage to pump up the US economy in the form of tax reductions and a reduction in bureaucracy. Without judging the end result of these moves in terms of income inequality and business risks further down the line, we do think the possibility of a short-term uplift in the US macro should not be ruled out. First the pain, then the gain. Knowing the broader plan and having clarity on tariffs might be seen by the market as a clearing event in April and could start the (temporary) recovery. The second factor is more structural in nature and centres around the de-risking out of the US. As per data provided by FactSet through early March, the US share of global market capitalisation fell from about 51% in 2002 all the way to 30% between 2008 and 2012, until Fed policy started to kick in with ultra-cheap financing, driving money back into the US economy and returning the US share of global market capitalisation to an all-time high of about 52% in 2024. The Mag7 is the most likely explanation, but it is a tricky one, and we have referred to it as “chicken equity” in our past monthlies. Portfolio managers were closing their relative underweights to Mag7 because of stock price momentum, thereby pushing up the market cap even further. We believe that de-risking out of the US and re-investments into domestic economies will push down the US share of global market capitalisation. We are not sure what the ultimate number will be (as in: does it go all the way back to 30% levels or stabilise somewhere between 35%-45%), but the direction is clear. Beneficiaries are, in our view, European markets as well as China and some select countries in Latam (if politics remains accommodative in both regions).

Our FinTech portfolio was also affected by the broadening of the market, in addition to the retreat out of the US. Since we diversify across the globe, the uplift in returns from the former effect more than offset the latter. In absolute terms, the Fund was down for the month but performed very well in relative terms. Performance was also strong versus peers (which are much more tilted to high-risk names), bringing the monthly, year-to-date and initiation-to-date data all into the top quartile. Not owning Mag7 contributed about two-thirds of the outperformance for the month. The rest came from stock selection, where we benefitted from our allocations to Europe and Asia in particular. US payment stocks detracted, but we started to reduce our exposure there, so the impact, albeit negative, was less pronounced than in previous episodes. Allocations to high-growth, low-profitability businesses is, historically, out of the scope of our mandate, which is focused on quality growth at a reasonable price. These low-quality companies were hit particularly hard in March and not owning them was a good strategic decision. That strategy puts us in the more conservative bracket of our peer positioning. We didn’t opt to reduce exposure to some US names that sold off much further, as we also aim to benefit if the first scenario described above unfolds, where the US economy gets a temporary boost from tax and paperwork cuts. It’s a balancing act.

Both allocation and selection contributed positively to last month’s return. In terms of the FinTech themes, Enabling Technology performed worst (-4%), followed by Established FinTech (-1.1%) and Upcoming FinTech (-0.12%). The stocks that contributed most to the Fund’s relative performance in March were Flatexdegiro (+16.1%), Rakuten Bank (+15.3%) and Allfunds (+10.1%). The worst performances came from Block (-16.8%), Verint (-20.9%) and Endava (-18.4%). The portfolio’s current positioning comprises 43% Established FinTech, 37% Enabling Technology and 20% Upcoming FinTech.

Market Review

The UST 10-year yield was flat during March, at around 4.25%. The Bloomberg Commodity Index was up 3% intra-month, mostly driven by soft commodities, with energy flat for the month. The VIX ended up at around 22 versus 20 in the previous month. That is very surprising. The significant uncertainty around tariffs has had an effect on markets but not on the VIX. If market fears materialise further, we expect the VIX to rise accordingly.

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 March, we didn’t make any big structural changes, with no new additions or sales. However, we did shift weights in the US out of payments and into other parts of the market. We brought Intuit back to model weight (2%) and took profit in the payment names that were above model weights due to strong market performance last year. Furthermore, we let our Europe and China exposure increase with momentum, as we don’t think that theme is played out yet.

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,

Silvercrest–FinTech investment team