Tech firms’ turn to face regulatory mountain and consumers’ ire; financial firms to outperform
The rapid growth of the technology sector, led by the FANG ( Facebook, Amazon.com, Netflix and Alphabet’s Google) stocks, has been dominating headlines and investors’ attention for a decade. Having conquered the wallets and minds of billions of consumers, they are starting to shift their attention to traditional industries, seemingly threatening to upend the business of banks, for example.
The tech companies claim to be able to provide financial services either more efficiently or at a lower cost. Traditional banks are seen as lumbering old incumbents with their lunch about to be eaten by tech rivals.
Fin beats tech
Kelly Chia, executive director of research at Julius Baer, is not too worried that the incumbent financial services industry is about to give way to tech companies.
The way Chia sees it, tech companies will still be able to outperform in the next couple of years, but they will face growing scrutiny from regulators. It did not really help their cause when Facebook attempted to create and lead a consortium to launch a virtual currency. For central banks, especially that of the US, this is a challenge to the sovereign right to issue currencies. “The US is not going to let the US dollar be marginalised. It is probably the most powerful thing in the world,” says Chia in an interview with The Edge Singapore.
While the attempt to launch its virtual currency Libra has stalled, Facebook and other digital economy giants have already riled up regulators enough to make them pay closer attention. “They are approaching a very high regulatory mountain — the Mount Everest that the banks experienced 10 years ago. The banks know what it means to be bitten a lot of times. If you want a position in the next decade, you should position in places where you are past the regulatory peak,” says Chia.
“If you look at the number of times [ JPMorgan CEO] Jamie Dimon and gang have been hauled up to Capitol Hill versus [Facebook CEO] Mark Zuckerberg, the contrast is stark. The former are guys who have already scaled the peak and are coming down, versus the guys who are trying to potentially eat our pie. They will now have to climb this mountain. So, I don’t think this aspect about tech companies eating the banks’ lunch exists anymore; there’s less of this fear.”
While jurisdictions such as the UK, Hong Kong and Singapore have awarded or are planning to award virtual banking licences, the interested parties face “very, very high hurdles” and therefore are not in a good position yet to take the incumbent banks head-on.
Besides regulatory intervention, there is market reality at work too. According to a Bank of America study, banks are the largest customers, by sales, of fintech companies. “Why would you bite the hand that feeds you? So, it will not be a competitive landscape anymore, but more of a collaborative landscape. It means I supply my [artificial intelligence] software to you, so that you know your customers better. But this makes the banks even more robust. So, that’s something. Moving into the next decade, financials could actually outperform tech, simply because financial firms are past their regulatory peak,” says Chia.
Consumers, with a growing awareness of their rights, are starting to demand the privacy many had given up in exchange for free, convenient digital services. For example, the search engines owned by Google have been described by some as better attuned than one’s spouse to what one thinks.
As consumers get more savvy about protecting their digital privacy, entire business models of internet companies can be undermined. “In certain jurisdictions, they are already saying they will not be able to target a person based on sites visited. The big-platform guys are seeing that privacy is more important than profits, and they are moving fast to address this issue,” says Chia.
Responsible investing
Similarly, as consumers who value their privacy over convenience, investors are starting to be less obsessed with just making money. There are wider issues at stake, and Chia sees this as another growing theme for the coming decade.
“We are really engaged in responsible investment. The value of the company drives the culture, which in turn drives the actions, and this is something that we believe will be the differentiating factor in the next decade. This is something we are moving into — not just performance, but performance with a purpose,” says Chia.
In the past few years, the financial markets have been wowed by the rich valuations well-funded venture capitalists and other private-equity firms are willing to give newly emerging companies. The chase for the next “unicorn” — a start-up worth more than US$1 billion — hogged many headlines and seized the imagination. There is an estimated US$2 trillion ($2.7 trillion) in “dry powder” waiting to be put to work, potentially inflating the excesses in the private-equity market.
Thanks to the high-profile stumbles of first Uber and then WeWork, the excesses are slowly being deflated. Without the disappointing IPO of Uber and failed one WeWork, the private-equity bubble would have suffered from a “pop” instead of a mere deflation, and it would have been quite painful, notes Chia.
“We need to rein in the excesses; we are looking for a ‘purpose with performance’ kind of mindset when we talk to companies. As we move into 2020, one very important aspect of investing is profit for good, lots of climate-related discussions, governance and social-related things, which will drive how companies position themselves to make money,” he says.
De-equitisation
Chia has observed recent market phenomena, which have signalled new norms of the market. The US bond yields are now at very low levels, and the yield curve has inverted again — an indicator that has predicted recessions with 100% accuracy. “You have to give it some respect,” warns Chia. Now, a reason bond yields are low is that central banks are exerting a big influence by both buying and talking down the yields.
So, the yield curve is supposed to signal an impending recession, but the US economy is still growing, albeit not at a quick pace. At the same time, US equity markets are hitting new highs regularly. “We are arriving at a conclusion that the stock market is more indicative of the economy than the other way round sometimes. So, they are linked, obviously. If you don’t feel good about the economy, you don’t tend to invest in the stock market, and marginal buyers don’t push the market up,” he says.
There is also the trend of “de-equitisation”, which refers to the gradual drop in the supply of shares issued and available for investors to buy from the market as companies actively buy back their own shares, which are then cancelled. As a result of the active share buybacks, the number of US shares is shrinking at a rate of 1.5% a year, according to some estimates.
This trend is partly helped by the low cost of borrowings, so companies issue bonds instead of placing new shares when they need new funding. Companies such as Microsoft have been well rewarded for their share buybacks. Over the past two decades, Microsoft has reduced its total number of shares by 28%. Investors alone have pushed up Microsoft shares by 50% over the past year.
In other markets such as Singapore, companies that are able to do try to reward investors with more generous dividend payouts — or the perception of one. “DBS [Group Holdings] made a shrewd move: It went to quarterly payouts. The amount given is the same, but shareholders don’t need to wait for half a year; that’s the incentive for them to just hold on,” says Chia. The Singapore REITs, of course, are enjoying a good run because of their yield.
Share buybacks and dividends are different mechanisms, but both reward shareholders in their own way. Depending on the tax structure, companies can choose either or both, and please their shareholders. “It is the new way investors are looking at investing in companies. So, if you have this aspect in your shareholder return, you tend to do quite well,” he says.
Retooling Singapore
Amid the big changes across sectors and markets, things are happening in Singapore as well. The country’s top-line economic growth might not have changed much, but the composition has.
Chia notes that the government has actively led the transformation of the economy. In the 2000s, global pharmaceutical companies were enticed either to set up their headquarters or carry out their R&D here. As a result, the healthcare sector boomed. In the following decade, as the digitalisation of business accelerates, the major players of the internet economy have been drawn to set up significant operations here too. From 2010, Facebook, Google, Netflix have joined Microsoft in expanding in Singapore.
Critics might have wondered whether these Western MNCs have been really beneficial to the locals, the Singapore government has made it relatively easy for the companies to hire foreigners. Chia offers an anecdote as an answer. Julius Baer is located at Marina One, one of the newest Grade-A office developments. The private bank takes up one floor, but Facebook takes up a floor space that is several times bigger in the same development. What Chia sees and hear makes him upbeat.
“When I took the lift just over a year ago, the Facebook staff were mostly non-locals. Now, when I go in, I can hear quite a lot of Singaporeans. We cannot downplay this aspect: the retooling of Singaporeans to hold much higher-value-added jobs in nascent industries,” he says. E