Attracting the Next Generation of Investors in Nigeria: Incumbents vs FinTechs
Traditional investment managers have lost the narrative to FinTechs
FinTechs have exploded in Nigeria for some time now, with start-ups emerging strongly in various areas of financial services. The inroad has been particularly strong in payments where they clearly lead, banking with digital banks, insurance with insurtechs, investment management with wealthtechs and savingstech, and many more.
Interestingly, one area that has receieved more attention is around digital banks posing a credible challenge to traditional commerical banks. I think the optimism is misplaced, but that’s a topic for another day. I want to focus on where the FinTechs are doing remarkably well, which is in investment management/brokerage. My assessment is not about size or profitability, in which incumbents clearly lead, but about a shift in narrative.
Before I proceed, let me explain why investment management/brokerage is an easier play compared to banking. Regulation is strict in both segments but the scrutiny is higher for banks as they undertake more risk (via lending). Banking requires more capital than investment management, which means entry to the latter segment is easier. Even in managing risk, banks have more robust systems, given the types of assets they hold and the attendant risks. Another distinction that clearly separates big traditional banks (Tier-1) from FinTechs is their ability to attract low-cost deposits, which drive low cost of funds (interest paid on liabilities used to generate income) and support profitability. No digital bank can compete on that level, especially when by their very nature they tend to subsidise users and pay high interest rate on deposits.
In investment management/brokerage, competition is less intense. There are many ways around regulatory requirements, scrutiny is not as high, risk management is strongly needed but can be lax and capital requirements are really low. It’s the perfect space for start-ups to operate and they have capitalised strongly on these low entry barriers. Even more, they are dictacting the narrative and winning hearts.
The perfect way to tell this story is to highlight how the landscape changed in 2020. Yesterday, a colleague tweeted about how local naira assets have performed strongly and why investors should not completely shy away from opportunities at home. He charted these returns, and as you can see, the performance in local equities and selected bonds were strong.
Chart 1: 2020 Returns Across Selected Local Assets
This is an excellent point because we can’t invest in USD all the time, not when we have Naira obligations. Also, above inflation returns can help retain investors in the local market but they must know where to seek these returns. And that was the problem in 2020 because I don’t believe young retail investors were knowledgeable enough to spot the opportunities.
I think the narrative strongly shifted against investing in the local market, with 2020 serving as an inflection point. This shift has been driven by FinTechs while incumbents have struggled. To shed light on this, I have decided to explore three crucial questions, which are discussed with the competitive investment management landscape in mind. Did choosing to invest abroad hurt the retail investor? Would this opportunities at home have been tapped by a young retail investor? Is this performance enough to attract the young millenial investor going forward?
Did choosing to invest abroad hurt the retail investor?
I think a lot of retail investors gained more from investing abroad in USD. For instance, the US S&P 500 and Nasdaq indices gained 16.3% and 43.6% respectively in 2020. As the USD appreciated against Naira by around 30.6% in 2020, that’s a gain of 46.9% and 74.2% respectively in Naira terms for investors tracking the broad indices. And indeed, most young Nigerians were exposed to technology stocks which outperformed in 2020 due to a combination of global stimulus and better resilience against COVID-19.
One area where incumbents (and indeed FinTechs) can better serve retail investors is in risk guidance. While there were strong equity returns across board in 2020, this is not always normal. Many young retail investors are yet to understand that investing in a small number of stocks, especially with the same risk profile, could expose them to steep losses. A way to protect that is investing in index funds/ETFs and USD fixed income funds which are professionally managed and offer predictable returns. In the case of the latter, not enough FinTechs provide the opportunity to invest in managed USD fixed income funds but these are usually managed by incumbents. And incumbents have failed to drive conversation around this, same as FinTechs, but at least they are on the front-foot with the next generation. Ultimately, even they would have to prioritise that when markets become turbulent.
Would this opportunities at home have been tapped by a young retail investor?
I think young retail investors had reduced chances of benefitting from the wave in 2020. Retail investors were a major driver of the performance of local equities in 2020 (as local participation in the market topped 60%) but I have singled out young investors because in my experience of working with a brokerage firm, clients were usually older. Young investors are not that bullish or excited about local stocks for good reason. Since 2015, for instance, the equities market has only gained twice (2017 and 2020) in 6 years. Also, the Nigerian equities market is yet to overcome its legacy as value destroyer given the experience of our parents after the 08/09 global financial crisis - indeed the market is yet to recover till date (chart 3). Meanwhile, equities have strongly recovered beyond pre-crisis levels outside Nigeria. Put simply, there is no confidence locally. Interestingly, FinTechs are doing more lately to encourage participation in equities than traditional brokerage firms. A simple test is to ask 10 of your young friends how to buy shares.
Chart 2: NSE Annual Return (2015-2020)
Chart 3: NSE Return Index (2007-2020)
Another point is that when investing in Nigeria, retail investors have preferred short term instruments like treasury bills or money market mutual funds over the past years. They were attractive before 2019, not in 2020. This is because post 2015, monetary policy was tight and interest rates on money market instruments were high, effectively protecting against inflation. The explosion in such investment is clear from chart 4 below. Money market mutual funds held an estimated share of 70.7% in 2019, with fixed income and bond funds which hold long term assets having a share of 13.3% and 4.4% respectively. For young retail investors, FinTechs also promoted these mutual funds through partnerships with incumbents.
Chart 4: Structure of Managed Funds (data is sourced from SEC)
Between 2019 and 2020, as interest rates reduced sharply (to around 0.5% for treasury bills from peaks of 14-20%), money market funds delivered poor returns - around 2% from chart 1 above. In chart 4, you can see the reduced share of money market funds, which actually fell to 47.4% from 70.7%. Retail investors shifted their attention elsewhere to protect their investment against high and rising inflation (12-14%). This shift was both prompted by FinTechs offering opportunities for dollar investment (USD mutual funds, global equities, USD savings etc) as well as retail investors becoming better educated and taking initiative. After all, they weren’t new to the risks of sudden, sharp devaluations and high inflation. While FinTechs were doing this, traditional asset managers could not find a quick, seamless solution to dollar sourcing and some even raised limits for USD investing (Stanbic, for instance, raised minimum entry to $10,000 for a fund).
In this same market of low interest rates, there were opportunity for wins but this is restrictive. The opportunity was for sophisticated investors who understood fixed income trading and had the imagination to shift to long-dated securities which increased in price as interest rates fell. Young retail investors don’t have enough financial education to do this, neither can they even purchase these securities directly. Besides, in times of high interest rates, which obtained prior for an extended time, there were huge risks to this strategy - interest rate risk could mean losses. While the entry path for retail investors to benefit from this opportunity would have been through fixed income/bond funds, these were not well known and were not marketed as such by incumbents. The fixed income and bond funds share of assets increased to 27.1% and 14.2% as at December 2020 from 13.3% and 4.4% a year earlier. That was a missed opportunity to retain local interest among young investors. Talking about the weaker returns on treasury bills was a popular commentary among retail investors in 2020, not the rising double-digit returns on bonds.
Is this performance enough to attract the young investors going forward?
I think it is clear that traditional asset managers have not done well to attract the next generation of investors. The performance of local assets in 2020 is also unlikely to be repeated going forward because equities and long-dated debt securities are not as attractive when interest rates begin to rise. Meanwhile, the next generation of investors have been shaped by two crises (2016 and 2020) which have created the good impression that it is essential to protect against currency devaluation. Given the slow speed of innovation with traditional asset managers, restrictive regulation (which hinders product development) and failure to shape narratives, it would be hard to attract these young investors.
While FinTechs are not as big, they are clearly ahead in the race to attract the next generation of investors. They have won their trust, improved their experience, exposed them to outside markets, facilitated transactions where incumbents have failed (sourcing USD) and they are shaping the narrative ruthlessly.
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Informative.
Fantastic piece!!
I think the failure of the traditional asset managers to own the narrative is the biggest drawback that they have. Some of them have gone ahead to develop apps (although not as great as the fintechs') and some are even offering exposure to US markets like ARM stock trade but they still fail to appeal to the millennials and gen Z. Either ways, I think some of them will still win through the fintechs' win by the virtue of partnerships.