Fintech In Alternative Investments

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RESEARCH PERSPECTIVE VOL.87 AUGUST 2018 Download Research Perspective Fintech in Alternative Investments Oliver Fochler Managing Partner, CEO Tel.: +44 79224 36360 Email: [email protected]   Alexandros Kyparissis Analyst Hedge Funds Tel.: +44 78431 44007 Email: [email protected]   Fintech is spanning across asset classes and is dominating in most of them as the key theme. The industry is de facto growing, but investors should not ignore the risks. The majority of start-ups fail according to Forbes, a fact emphasizing the need for proper investment due diligence or manager selection depending on the desired exposure to the sector. The world is moving towards new technologies and innovations and investors need to adapt, without disregarding the essential discretionary/human element. Figure 1. Alternative Investments and Fintech, Source: Stone Mountain Capital Research   It is important to define the spectrum of fintech and the array of the solutions offered. In Stone Mountain Capital, we identified the following sectors and products that fintech companies apply their technology to:  Insurance Wealth Management/ Financial Planning Investment/ Advisory/ Trading Compliance/ Anti-Money Laundering (AML)/ Know Your Customer (KYC) Debt Syndication Trade Finance Mortgages Data Analytics Banking and Payment Solutions Distributed Ledger Technologies Smart Contracts for execution Cryptocurrencies Cybersecurity Direct Lending Crowdfunding Machine Learning/ Artificial Intelligence Technological breakthroughs constitute integral part of evolution in our age and assist in humanity’s acumen, development of services and product innovation. Indubitably, the focal point recently is Blockchain technology and its applications across industries. According to a PwC survey, blockchain finds its applications useful in a plethora of industries with the future seeming auspicious for the financial services, hence this perspective focusses on the fintech spectrum. Healthcare and hospitality industries are also alluring venture and corporate investments, without excluding private equity, private debt and hedge funds, who eye lucrative investment opportunities in these industries. Figure 2. Blockchain investments by Industry, Source: PwC 2017 Global Digital IQ Survey According to Ernst & Young’s Adoption Index, China, India and United Kingdom have the highest adoption rates and these numbers are expected to grow especially due to a revamp of payment solution and insurance services. Direct Lending via online platforms has a discernible effect on the market’s growth and constitutes a salient point for discussion amongst investors. Figure 4 highlights the increase in capital invested from venture capitalists in fintech companies, despite a decrease in the number of deals over the last two years. The vast majority of capital was raised as seed or series A, B & C and less on private equity, debt and post-IPO equity. Figure 3. FinTech adoption rates across 20 markets, Source: EY FinTech Adoption Index 2017 Figure 4. VC Investment in Fintech 1Q16-1Q18, Source: Crunchbase   Europe, and the UK especially, is the home for many major players in the alternative lending space such as Zopa and Funding Circle and has seen the commitments in the region surging to record levels according to Pitchbook data. What is remarkable in Figure 5 is that fintech has raised until July 2018 similar amounts to those raised in prior to 2017 years. European venture capital has raised $4.2bn and half of those account for UK closed-ended funds, underlining the importance of Brexit for the landscape. The institutionalisation of the market and its development was showcased earlier this year with the European Investment Fund (EIF) and KfW investing in Funding Circle’s securitisation and the first listing of a fintech investment trust, Augmentum Fintech Plc, backing fintech lenders and crowdfunders as a VC partner, on the London Stock exchange. Figure 5. VC investment in European fintech companies from 2013 to July 2018, Source: Pitchbook A report from by P2PFA, the UK Peer to Peer Finance Association, for 1Q18 reveals that cumulative lending via its platform members is approximating £9 billion in loan originations financing more than 50,000 businesses and over 200,000 individuals. It is easily comprehended that the online lending market is growing, and the market dynamics have altered mainly because the banks do not compete with platforms, but rather collaborate with them by providing facilities and warehousing lines of credit. Deloitte reported that investments into fintech lending are forecasted to increase to almost $11 billion in 2018, while the amount in 2017 and 2016 were $9.3 billion and $9.4 billion respectively.   Another funding source for start-ups, which traditionally struggled to access finance for their projects, is equity crowdfunding facilitated by fintech platforms such as Crowdcube and Seedrs. Investors such as venture capitalists and other individuals without deep pockets are having access to multiple early stage products and ideas. These platforms perform initial due diligence on its listings which assists the less sophisticated investors with complicated business models. For later stage companies, private equity funding is really surging in the market, and combined with the limited set of opportunities, are driving valuations high. The adoption rates are still low as seen in Figure 3, hence attracting private equity firms that eye massive opportunities in this space.   On the other hand, hedge funds would rarely invest in early stage companies, so they gain exposure via sectors that are susceptible to disruption and innovation such as TMT, energy and healthcare. Investing in disruptive tech could be challenging due to the abundance of products and services that are gratis offered and not generating sturdy returns. This make the manager selection essential searching for managers that can identify successfully solid technologies and themes that will change the world. Themes that dominate the hedge fund world are urbanisation, artificial intelligence, environmental sustainability, robotics, 3D printing, next generation self-driving cars, cloud computing, crypto and cash digitalisation. Equity hedge strategies that pursue those themes have performed extremely well over the last years and have been one of the top-performing strategies among the hedge fund universe. Moreover, hedge funds themselves are becoming a hub for scientists and are metamorphosing themselves into tech companies by developing their own sophisticated systems for trading and operations. The use of machine learning, algorithms and big data are the core techniques applied by CTAs and systematic funds to design their strategies and manage their portfolios. Investors have not lost their interest in CTAs despite the underperformance of last years and they are still seeking to eliminate human biases and relying on behavioural predictive analysis and big data for investments. CTA’s assets under management peaked at the end of 1Q18, bolstering the previous years’ trend of allocating to systematic strategies. Figure 6. CTA Industry Assets under Management from 2000 to 1Q18, Source: BarclayHedge, Stone Mountain Capital Research     A number of CTAs have an eye on volatile assets, consequently investing in tech and crypto. The underlying volatility of Bitcoin combined with the institutionalisation of the market with the introduction of futures contracts and other index-related products such as ETNs, have captured the interest of CTAs and has led to the launch of crypto specific funds. According to Autonomous Next, the number of active crypto funds has surpassed 300 competing in a market of $256bn capitalisation and 1754 cryptocurrencies. Bitcoin and Ethereum account for 63% of the market cap, but both of them are struggling after last year’s rally.   Crypto is not equal to trading cryptocurrencies but constitutes a vehicle for funding project in the “digital world”. ICOs have become the alternative to venture capital and traditional stock markets for many start-ups that build their business on blockchain. The most common platform for an ICO fundraise is Ethereum, whose smart contract functionality makes the platform appealing. The issue with ICOs is its legitimacy, with People's Bank of China and the South Korean government declaring ICOs illegal. On the other hand, the SEC Chairman states that most ICOs classify as securities, South Koreans are revising the ban enacted in 2017 and Germany's second-largest stock exchange is developing an ICO platform. Total ICO size has more than doubled compared to 2017 and the number of ICOs has also increased compared to last year according to data from Coindesk, highlighting the growth of the market. Figure 7. Total ICO Size and number of ICOs, Source: Coindesk   In Stone Mountain Capital, we believe that comprehensive alternative investment advisory should reach across asset classes and interface between illiquid investments like real assets, infrastructure, venture capital, private equity, private debt, real estate and more liquid investments like absolute return strategies, hedge funds and fund of funds. Our main target is to achieve an optimal asset allocation for our clients in terms of performance, risk and liquidity under consideration of investment structure, size, and track record. Cross asset advisory implies an in-depth analysis of asset specific risk factors. Therefore, we provide the most sophisticated credit, market, operational, liquidity and integrated risk advisory.   This perspective is neither an offer to sell nor a solicitation of an offer to buy an interest in any investment or advisory service by Stone Mountain Capital LTD. For queries please contact Alexandros Kyparissis under email: [email protected] and Tel.: +447843144007. For further information around our research and advisory services please contact Oliver Fochler under Tel.: +447922436360 and email: [email protected].  The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer. STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London. We are advising 30+ best in class single hedge fund and fund of fund managers across equity, credit, and tactical trading (global macro and CTAs). In private equity and private debt, we advise 10+ general partners across the sectors real estate, infrastructure / real assets and capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. As per 19th July 2018, Stone Mountain Capital has total alternative Assets under Advisory (AuA) of US$ 52.3 billion. US$ 48.2 billion is mandated in hedge fund AuM and US$ 4.2 billion in private assets (private equity / private debt / real estate) and corporate finance. Stone Mountain Capital has arranged new capital commitments of US$ 1.28 billion across hedge fund, private asset and corporate finance mandates.   Our Team   Our Solutions   Our Mandates   Our Research   Our News Contact We are able to source any specific alternative investment search and maintain relationships with dozens of best-in-class hedge fund managers, private equity and private debt general partners (GPs) and real estate and infrastructure developers. We don’t pass any costs on to our investors, since our compensation comes from our mandated managers, GPs and developers. Please contact us, should you require further information about our solutions. Stone Mountain Capital is a limited company (LTD) registered in England & Wales with registered number 8763463. The registered address is: 31 Compayne Gardens, London NW6 3DD, England, United Kingdom. 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Stone Mountain Capital LTD conducts securities related activities in the U.S. pursuant to a Securities and Exchange Commission ('SEC') Rule 15a-6 Agreement with Crito Capital LLC, a U.S. SEC registered broker-dealer, and member of Financial Industry Regulatory Authority (‘FINRA’), Securities Investor Protection Corporation (‘SIPC’) and Municipal Securities Rulemaking Board (‘MSRB'). All information in this perspective including research is classified as minor acceptable non-monetary benefits ('MNMB') in accordance with article 11(5)(a) of the MiFID Delegated Directive (EU) 2017/593 and FCA COBS 2.3A.19. Cautionary Statement on Forward-Looking Statements This research may contain forward-looking statements concerning business, operations and financial performance. Any statements that are not of historical facts may be deemed to be forward-looking statements. You can identify these forward-looking statements by words such as "believes", "estimates", "anticipates", "expects", "plans", "intends", "may", "could", "might", "will", "should", "aims", or other similar expressions that convey uncertainty of future events or outcomes. Forward-looking statements include statements regarding our intentions, beliefs, assumptions, projections, outlook, opinions, analyses or current expectations concerning, among other things, results of operations, financial condition, business outlook, the industry, sector or region in which we operate or for which we provide research and the trends that may affect the industry, sector or region or us. Although we believe that we have a reasonable basis for each forward-looking statement contained in this research, we caution you that forward-looking statements are not guarantees of future performance. All of our forward-looking statements are subject to known and unknown risks, uncertainties and other factors that are in some cases beyond our control and that may cause our actual or our research results to differ materially from our expectations. Except as required by law, Stone Mountain Capital LTD undertakes no obligation to publicly update any forward-looking statements for any reason after the date of publication in this research, our website, or on linked websites, whether as a result of new information, future events or otherwise.   Risks Investments in alternative investments are speculative and include a high degree of risk. Investors could lose their entire investment. Past performance is not necessarily indicative of future results. The risk of loss in trading interests can be substantial. You should carefully consider whether such trading or investment is suitable for you in light of your financial condition. Alternative investments are suitable only for persons who are able to assume the risk of losing their entire investment. Alternative investments often engage in leveraging and other speculative investment practices that can work against you as well for you; may increase the risk of investment loss; can be highly illiquid; may have restrictions on transferring interest; may have no secondary market nor is one expected to develop; are not required to provide periodic pricing or valuation information to investor; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds or other investment vehicles; can have volatile performance; may be subject to substantial fees and charges for management, performances, advisory and other fees compared to other investment vehicles, and these fees and charges can offset profits. Alternative investment managers have total trading authority over their funds. 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