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Innovation in financial services tech is disrupting the big banks and independent platforms are reaping the rewards, says Pengana fund manager Ed Prendergast.

What is driving growth among small players in financial services?

New players are emerging in the investment platform space as new technology is taking market share from the big four banks. The bank’s tech has been slowly superseded, largely due to their size and the difficulty in making wide-scale changes to the backbone of their tech.  

Small guys coming into the space have much more modern architecture and are able to be much more agile with what they can offer.

There is also a trend in the planning industry to move away from bank-aligned groups, hence these planners are also looking for an alternative to the bank platforms.

The technology of the emerging platform companies is more flexible, can more easily implement changes to portfolios, and are cloud-based hence easily accessible from different locations. The reporting is better and there are less manual interventions needed by the financial planner.

Do the small players pose a real threat to established institutions?

The three listed players we have exposure to, Netwealth (ASX:NWL), HUB 24 (ASX:HUB) and Praemium (ASX:PPS), have between them less than 3 per cent of the market.

But there is huge room for growth – they now take a large proportion of incremental flows into the platform market as planners realise the benefits.

The stocks have performed well of late, however there is still room for upside based on further market share growth from a low base. If they eventually reach say 20 per cent of the market combined over a ten year period, that will still be enough to justify investment.

Big players like Westpac’s BT have released a new version of their platform called Panorama that cost them over $600 million to build but our feedback from planners is that the changes merely bring them up to the same standard that already exists in the newer platforms.

Even if banks can offer an updated platform, there is a general trend for financial planners to be independent from banks and these smaller players can only benefit.

In the same way that the telco sector was disrupted by smaller nimble players and Telstra lost market share, platforms like NetWealth or HUB 24 are shaking up the market.

How can investors differentiate between ‘AdviceTechs’ and are there too many in the market?

A platform like Praemium (ASX:PPS) has a speciality for separately managed accounts which is a subset of financial advice.  Its rapid growth is driven by a shift towards this style of financial planning, however the market is more specialised and therefore smaller than the broader platform market.

Hub24 (ASX:HUB) and Netwealth (ASX:NWL) are direct competitors of the bank platforms but they can both gain despite being similar because of the huge market share opportunity. There can be more than one winner.

Our feedback from financial planners is that they are both good, and both better than the banks. The two would have just 0.5 per cent and 1.5 per cent of market each, but their funds under management are continuing to see very strong growth.

Their share prices have all done very well, on the surface they don’t look cheap but if you start to play with scenarios you can see their potential. They are growing from a low base and given the industry structure they are well poised for strong growth. Over time we would expect profit margins to expand as the cost base does not need to grow in line with revenue.

Is there a future where these non-bank platforms might overtake the majors?

There will always be a certain portion of the market that are aligned and will never leave the banks. Often the biggest impediment to change is inertia – for financial planners to change platforms is not easy so they need to be really dazzled by what the technology can do.

Some simply can’t be bothered but I don’t think there’s anything completely implausible about getting a 20-30 per cent hold of the market between the newer players over the long term.

How will the AdviceTech sector grow in the months and years to come?

The share prices of those mentioned above are doing well and that will bring in copycats and other players. But the barriers to entry are very high. Any new entrant needs to build superior technology, and prove that it works consistently on scale. Planners will not shift to new platforms until they are fully proven.

Other players like Onevue (ASX:OVH) and Managed Accounts (ASX:MGP) are in the same space trying to get a hold, but brand new technology companies will face an uphill battle convincing planners to take a view on their technology.

Shifting platforms is highly disruptive to the planner’s business, hence convincing them to change is not just as simple as buying copy paper from a new newsagent.

Platforms charge a small proportion for the money they manage – roughly 0.6 to 0.7 per cent – but as new tech comes in at a lower price that is ultimately passed to the investor.

What should retail investors look out for?

While the opportunity in this sector is exciting, the risks are high. The rapid growth rates have resulted in high valuations, hence if the growth rates slip, the share prices could be volatile. We certainly take a long term view and consider the likelihood of these platforms continuing to beat the expectations of growth as high. But due to the high risk nature of the sector we keep a modest sized investment within our balanced portfolio of 60 stocks.

 

Ed Prendergast is the co-manager of the Pengana Emerging Companies Fund, and established the Fund in 2004 with Steve Black. Prior to joining Pengana, Ed was a Director of Citigroup, and Head of the Small Companies research team.

In total, Ed spent 10 years researching small companies for stockbrokers – primarily at Citgroup and ABN Amro, and was the top-ranked analyst by BRW in 2003 and 2004.

 

This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.