“I been in the right place, but it must have been the wrong time
I’d have said the right thing, but I must have used the wrong line
I’d have took the right road, but I must have took a wrong turn
Would’ve made the right move, but I made it at the wrong time
I been on the right road but, I must have used the wrong car”
Dr. John, legendary bluesman
Poor Dr. John. He never did get it all together in that song, but at least he knew it. He understood his plight. What he may have missed and what might have given him some comfort — if comfort is even a goal of an inveterate blues man — is that even if he had made it to the right place at the right time, took the right road and had the right line, he may still have not succeeded. At least not if he had been managing money instead of playing the piano.
Wayne Gretzky thought he had it figured out. When asked about the key to his success in hockey, he famously replied that he doesn’t skate to where the puck is, but rather to where it is going to be, another partial cure for an active asset manager. Gretzky should have admitted that he also needed at least one burly defenseman to screen the goalie and that it would be nice to have the Zamboni rolled out to clean the ice between his stick and the net.
Investing is not a game of good intentions. It is a business of results that are measured carefully and monitored consistently, month after month and year after year. And simply being in the right place, or even being in the right place at the right time, counts for nothing if you are not able to convert your prescience and timing to a quantifiable result, repeatedly, over a meaningful time horizon.
For several years, we have been saying that digital finance — private debt generated by digital finance platforms — is the right place to be and that it will remain so for many years to come. We have also said that success in digital finance investing requires more than just being in the right place: it requires a completely different approach and a distinct set of skills, tools and resources to manage both the classic challenges of fundamental investing and the complex engineering and technology requirements of engaging with fully digital platforms.
Over the years, we have invested in and built a firm that we think is unlike any other. It is centered around a methodical approach that identifies and evaluates what we believe to be the best FinTech operators in our orbit. It is also designed to engage seamlessly with these digital platforms to import the volumes of data that feed our analytics, enabling insight-based decision-making. We believe that our efforts have positioned HCG as a leader in the digital finance market.
These accomplishments add to our hard-won reputation as a desirable partner for platforms, a reliable go-to liquidity provider for special situations, and a trusted issuer of privately placed bonds to support our financing strategy, attributes that grow increasingly valuable in increasingly uncertain markets.
At HCG, we believe that we are in the right place at the right time, with the right vehicle, and the right tools. As for Dr. John, his song may have been a soulful lament, but during his more than sixty years in show business, he won six Grammys, was inducted into the Rock and Roll Hall of Fame and was backed up by Mick Jagger and Eric Clapton, to name just a few. Enjoy!
Industry Update
In lieu of reviewing the macroeconomic data and industry updates as is our custom, the following highlights what we believe were the important trends and milestones in digital finance in 2018, and their impact on digital finance investing.
- Operating FinTech companies and their VC investors realized that FinTech credit platforms should be operators and not balance sheet players or asset managers. It seems that 2018 was the year in which the sector’s operators had the reckoning that venture capital firms were looking to monetize their investments at technology multiples of revenue (or even earnings) as opposed to a multiple of book value. The outcome: Digital loan originators that had prioritized holding originated credit assets on balance sheet have started to sell their inventory to asset managers and reposition their businesses towards more fee and service-based models.
- Banks thought it would be easy to compete and grab markets share from specialized FinTech players. They were wrong. Entering 2018, there were concerted efforts from Marcus (Goldman Sachs), American Express, and Discover, among others, to gain market share from the specialist FinTech marketplace operators yet as we enter 2019, they appear to be retrenching. We believe that the FinTech operators have developed a technology and innovation advantage that is enabling them to push farther into the bank’s turf than vice versa. The outcome: Well-capitalized, specialist digital loan platforms should, in our view, continue to grow their hold on the market, underscoring the importance of having fostered the right relationships with the right platforms.
- Focus on strong credit underwriting continues to be a critical success factor and has helped market leaders distance themselves from the pack of “me too’s”. Today’s market leaders have prioritized a commitment to sound credit underwriting and risk management. The outcome: Strong credit attracts and keeps investors, which in turn reinforces an operating business model, garnering capital support that ultimately enables growth. Copy-cat business models that deemphasized strong credit have suffered setbacks and had to retool their effort or exit the sector altogether.
- The latest wave of FinTech – one we label Wave 3 – is about building products that enable speedy access to cash assets. Wave 1 saw innovation around the marketplace model and the disruption of lending, across the loan value chain (origination, underwriting, servicing, and reporting) and across sectors (consumer, small business, real-estate, student, auto). Wave 2 saw an attempt at innovation but was really repackaged Wave 1 ideas. Wave 3 holds promise in that problems being solved by today’s new crop of startups are real, sizable, complex and impactful. They also benefit from a talent pool of former Wave 1 business builders and their ecosystem of human capital. The outcome: New opportunities, heretofore not recognized, are emerging. Examples include payroll financing, food stamp financing, and agriculture financing.
- Digital Finance Investing is mainstream. With over $100 billion originated in U.S. small balance digital loans by the top 10 platforms since their inception about a decade ago, the sector is anything but niche. Investment managers focused on digital credit assets, with the right knowhow, team and tools, have built investment programs to participate in this asset class. The outcome: A positive environment has been created for the endpoint stakeholders – borrower and credit investor. Borrowers get access to financing that was historically unavailable, often at better rates, with more transparency, and higher efficiency. The credit investor who bought the loans can gain access to an attractive fixed income security issued in a private market, also with meaningful transparency and higher efficiency.