A “paradigm shift” is taking place in financial technology.
Venture capital firms, which poured $117 billion into fintech startups from 2012 to 2016, have been pulling back on their investments. Meanwhile, established financial firms are positioned to step up their spending.
In a big note out to clients on May 18 titled “Fintech: A Gauntlet to Riches,” a group of equity analysts at Morgan Stanley said this shift will lead to an environment where legacy firms, or incumbents, “take the reigns”of financial innovation.
“Financials and payments incumbents are likely to be emboldened to step up R&D and take the investment lead, and this combination of VC/incumbent behavior represents a paradigm shift that should benefit incumbents’ [return on investment],” Morgan Stanley said.
The role of VCs will continue to diminish
Financial technology companies experienced a surge in funding from 2012 to 2015, during which time venture capital firms poured $92 billion into the space. Now it looks like those VC firms are experiencing a bit of a hangover.
In 2016, global venture capital investment in fintech companies dipped to $25 billion, from $47 billion in 2015.
In a recent interview with Business Insider, Amy Nauiokas, the head of Anthemis Group, a New York-based venture capital firm, described the time leading up to the dip as a “period of exuberance.”
“Big firms just sort of piled on a bunch of, let’s say, happy money,” Firms were thinking, we have money, we have capital, we have to spend it,” she said.
This environment of “happy money” sent valuations for fintechs to levels that some investors view as unreasonably high. For instance, Andy Stewart, a managing partner at Motive Partners, said at the International Fintech conference in London that valuations in fintech were “frothy,” or not connected to performance.
“Pullback in fintech investment over the past year is indicative of a realization of lower [return on investments] than initially hoped due to some unique challenges to disrupting in the financials industry, and our suspicion is that VC investors will continue to scale back investing,” Morgan Stanley said.