Nasdaq and investment bank Keefe, Bruyette & Woods recently announced the formation of the KBW Nasdaq Financial Technology Index to track fintech companies. KBW describes it as an equal weighted index designed to track the stock performance of U.S. companies that leverage technology to deliver financial products and services, and earn most of their income from fee-based sources instead of interest payments. This is an index, not an exchange traded fund (EFT), so for now it is useful only for tacking the performance of fintech stocks, and investors cannot yet buy the index as an ETF. I won’t be shocked if that changes before too much time passes. For now, the index can be tracked under the symbol KFTX.
I find the development of the index significant for two reasons. First, fintech is one of the more investable concepts that I have run across in the past few years. In 1972, Thomas Phelps wrote a book titled “100 to 1 in the Stock Market” in which he talked about the powerful returns that can be earned by identifying companies that would benefit from a changing world and hanging onto them for a very long time. One of my favorite intellectual exercises is to sit and think of those industries that offer the potential for decades-long periods of growth that could deliver 100-to-1 returns. Fintech is pretty high on the list.
While my primary focus as an investor is and always will be on community bank stocks, I find with increasing frequency that while in the process of researching banks and talking to bankers I run across companies that focus on product areas like cybersecurity, payment processing, loan underwriting algorithms and other technology areas that help bankers make more money with greater efficiently as well as increase their safety and security factors. A few of them have made their way into my portfolio and a bunch more have made it onto my watch list in hopes that I can buy them at more favorable valuations at some point in the future.
When the new index was announced, Fred Cannon, KBW’s global director of research, highlighted something about the fintech sector that’s not widely understood. “Some people see fintech as disrupters who are going to kill the big bad banks, but we feel it’s not quite that,” he said. “We feel that there are some big companies that are already providing financial services [companies with] technology.” There is a perception of many fintech entrepreneurs as Steve Jobs-type garage cowboys who are running around disrupting the banking industry. The real story is that many of the leading edge fintech products are being developed or sold by old line companies like First Data, Fiserv, Alliance Data Systems, VeriFone Systems and Fair Isaac. All of these are included in the KFTX.
There are some new cutting edge fintech companies in the index as well, including Green Dot, Global Payments and Square. Most of the newer companies in the index appear to be those involved in payments, and they deal directly with un-banked or under-banked consumers. They are not really a threat to traditional banks.
Those fintech companies that sell directly to banks tend to be older, more established players. There a key lesson here for younger fintech companies hoping to sell technology services directly to banks. Most banks are not going to be willing to take on the early adopter risk of doing business with new and untested technology companies no matter how exciting their products might be. Younger fintech firms are going to need to partner with older, more established companies that have been doing business for decades and have a large installed user base. The makeup of the new index acknowledges the reality that very few bankers will be willing to take on the reputation and career risk needed to deal with start up vendors.