Fintech

Navigating the fintech investment landscape

Navigating the fintech investment landscape. Photo: fill, CC0 Public Domain
Written by Nikhil Srivastava

Nikhil Srivastava interviews Atul Joshi, a Wharton alumnus and managing partner of the family office Raga Partners, about fintech investment.

What are the big trends you’ve seen in fintech over the past few years, and which developments excite you the most?

We’re really interested in the way shifts in talent, technology, and regulation are reshaping the financial services arena, and we think a lot about how we can leverage our expertise to embrace those trends in the companies we back and the entrepreneurs we support. More specifically, we’re focused on sub-sectors that we grew up in where we have an edge: investment management, capital markets, and banking.

Another thing that excites us is identifying analogs in other sectors. We get excited about ideas at the intersection of different fields, such as healthcare or pure sciences. In many cases, the most exciting opportunities emerge from those industries and have applications in financial services.

One example is iSentium. Innovation came out of a purely scientific approach towards language processing, and just five years later, the CEO had an ‘aha moment’ and realized that the nature of the company’s data had enormous implications for investment and risk managers. And though the core innovation had nothing to do with financial services, we got excited about helping the company add something very new in terms of next-generation market data.

We back talented, driven, passionate entrepreneurs who innovate and need help turning ideas into scalable products. This means working closely with the financial institutions we grew up in, as partners or customers. In some cases, it even means disintermediating them. Yet, by and large, we find that most of the companies we’re involved in are better suited by working with the incumbents than by disintermediating them completely.

Global banking revenues and profits by activity 2014 (in billions). Source: McKinsey Panorama – Global Banking Pools

Which companies look most interesting to you?

OpenFolio is an online community that allows you to link your portfolios and measure investment performance against your community and benchmarks that are relevant to you. It’s exciting to think about parallels between what OpenFolio is doing and what FitBit is doing by measuring your fitness relative to peers, or what 23andMe is doing by measuring your DNA or health against metrics important to you. Until now, the technology that OpenFolio has developed was very much in the domain of large-scale asset managers. Today, retail investors have those resources at their fingertips.

Their incentives are very different from organizations that are predominantly motivated to manage as many of your assets as possible
This also reflects another long-term trend in the business, the so-called unbundling of finance: the way applications have become virtualized, and integrations have become seamless between applications or investment providers. For example, you and I will no longer consolidate all our wealth with Merrill Lynch or another financial adviser; we’ll choose best-in-class providers within the niches we care about, whether it’s Vanguard for ETFs, FundRise for real estate, Lending Club for consumer loans, or Robinhood for equity. You can pick and choose your best-in-class provider, and companies such as OpenFolio help you unify that information and make sense of it. So, their incentives are very different from organizations that are predominantly motivated to manage as many of your assets, and as much of your wallet, as possible.

Estimize is another example of the power of crowdsourcing on a critically important data set: earnings estimates. When you think about what that team has built in relatively short order, and the quality of their information, it becomes increasingly shocking to me that big institutions and risk managers rely on outdated forms of earnings estimates to tune their models and make investment decisions. It’s early days, but one thing we’ve been very pleased to see is adoption not only by retail investors and day-traders, but also by the most sophisticated institutions and hedge funds in the world.

What’s your view on the current fintech investment landscape? With lots of investment dollars going into a very young sector, how will the landscape evolve?

When we started spending dedicated time on the space almost three years ago, the word ‘fintech’ wasn’t in most people’s vernacular. Now my three-year-old son knows it. What’s clear is that the secular shift in fintech is undeniable, and in my view, highly sustainable. It’s also clear that, as in any sector of investing, capital flows are cyclical, and what you’re seeing right now is a lot of money flooding into the system. We try not to get too distracted by that, and we focus on the companies and entrepreneurs we’re in touch with and ultimately on the things we can control.

By and large, valuations have clearly moved higher over time
By and large, valuations have clearly moved higher over time. We’ve mostly been beneficiaries of this trend, but we’re also very comfortable saying no to a valuation that makes no sense to us, or a magnitude of capital raise that we feel is mismatched relative to the opportunity the company is going after. Historically, we’ve seen big investors tell companies they won’t write a small check, so the company asks for more money. And we’ve seen differentiation between serial entrepreneurs and very thoughtful first-timers vs folks that are drawn to very large capital raises. I’m not sure there’s a single, right strategy or approach, but we feel very comfortable that the funding in our investments has been proportionate to the stage the company is in and to the immediate opportunity set.

We’re experiencing cyclicality within a secular trend. You’re already seeing the first wave of valuation markdowns (for example, with Fidelity mutual fund holdings) that have significant implications down the capital structure. If a preferred investment made by Fidelity is marked down by 25%, think about what that means for an early employee’s common equity valuation. If that employee is marking to market, he or she should make sure they have visibility into their incentives and their compensation that is right-sized for the current valuation environment. In some cases, that can be offset by cash compensation, but in other cases they may have to accept that the equity they received may be less valuable and less liquid than they expected. We see opportunities in talent movement over the next few years, and we believe large institutions may see still more rotation among their ranks.

Global fintech financing activity. Source: Accenture and CB Insights

What’s your advice for students looking to enter fintech investing?

First, Penn has no shortage of resources in terms of academics, career services, student and professor networks to take advantage of. Beyond that, for people going into the recruiting cycle: as difficult as it is not to follow the herd, it’s important to be true to oneself. Think about the companies recruiting on campus, how those companies fit within your career ambitions, and how many of them are simply a sign of the times. While there’s nothing wrong with going after popular openings that are available (candidly, I did coming out of college), it’s important to be mindful of how a job fits into one’s overall career ambitions.

For startups specifically, one thing that’s clear to me is that not everyone is cut out to be an entrepreneur. There’s a romanticized aspect of being an entrepreneur that has been popularized by the media and made worse by a selection bias towards successful founders. It’s important to be mindful of what it takes to be an entrepreneur: perseverance, well-roundedness, connectivity, the ability to work through cycles, the ability to devote a huge amount of one’s time and energy toward solving difficult problems. I think a lot of people mislead themselves into thinking they are that person. It’s important to know your limits; definitely take risks, but be true to yourself.

With financial services in particular, there’s a so-called ‘inside baseball’ in terms of the way business takes place in any part of the economy touching large sums of capital. In some cases, it may make sense at first to work within the system, to learn the inside baseball, to learn about market structure and trade secrets, and then take what you’ve learned and innovate outside of the system later on in your career. In our most successful companies, we see a commonality: innovation originates within an existing system, with founders taking what they’ve learned and innovating inside the system.

– This article is reproduced with kind permission, the interview having taken place 3 December 2015. Some minor changes have been made to reflect BankNXT style considerations. Read more here. Photo: fill, CC0 Public Domain

About the author

Nikhil Srivastava

Nikhil Srivastava is VP of growth for Wharton FinTech, as well as product manager and technical account manager for iSentium. He is pursuing an MBA in Entrepreneurial Management.

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