Blockchain adoption by private equity could pave the way for retail investors
Private equity adoption of blockchain technology is accelerating as the asset class increasingly sees it as a pathway to access the trillions of dollars of investable capital held by the world’s wealthy.
Market Leaders Hamilton Lane Inc., KKR & Co. Inc. and Partners Group Holding AG recently entered into blockchain partnerships with technology companies, paving the way for what could be the democratization of private markets.
The blockchain is a financial infrastructure or “digital ledger” that allows, among other things, the tokenization of funds. Tokenization involves dividing a stake in a fund into digitized fractions, making smaller investments easier to trade.
The technology is expanding the investor base for private equity, which is now mostly limited to institutional investors and high net worth and ultra-high net worth individuals who can afford minimum investments that often start in the millions of dollars.
Outside this limited circle of private equity investors is the global affluent mass, a group estimated at $80 trillion in investable capital. But in the world of private equity, where investors often meet fund managers in person before making commitments, going after that capital hasn’t been worth the effort and expense.
Blockchain adoption aims to change this dynamic by making it easier and cheaper for individuals to access private equity funds.
Great firm interest
Blockchain has attracted top private equity firms, suggesting that peers will likely follow as competition for investor capital intensifies. Partners Group in September 2021 became the first major private equity firm to tokenize one of its funds, according to ADDX Pte. Ltd., the Singapore-based digital stock exchange that performed the tokenization.
Hamilton Lane followed suit in March, teaming up with ADDX to tokenize one of its funds. Since then, Hamilton Lane has announced its intention to work with digital securities platform Securitization Inc. at create tokenized feeder funds for three segregated funds.
In September, KKR partnered with Securitize to tokenize a stake in the company’s $4 billion KKR Health Care Strategic Growth Fund II SCSp. At the time, Dan Parant, Managing Director and Co-Head of US Private Wealth at KKR, touted blockchain’s potential to open up private equity “to a new audience of investors.”
For now, there are limits to the size of this audience. Token funds are a good fit for retail investors, but US federal securities laws still restrict the asset class to affluent investors who meet relatively high wealth and income minimums.
There are also technical challenges. Steffen Pauls, founder and CEO of digital investment platform Moonfare GmbH, which manages $150 million in assets with US investors, said blockchain has yet to be used to manage capital calls, when private equity fund managers call on investors to deliver the capital they have already committed to a private equity fund.
“Right now, I think everyone is in exploration mode,” Pauls said. “The development is still very nascent.”
Access to both funds is still limited to accredited non-US investors. But tokenization has allowed Partners Group and Hamilton Lane to lower the minimum buy-in for funds to $10,000. In the case of the Hamilton Lane fund, this is down from the previous low of $125,000, according to the firm.
Private equity may be in the early days of its blockchain experimentation, but adoption is spreading across the financial industry, according to 451 Research analyst Alex Johnston, who tracks developments in data, l intelligence and analytics. The financial sector has been among the fastest to adopt blockchain technology, with almost a third of companies in a recent survey indicating 451 that they are already implementing the technology.
“Finance is not only already the most mature industry, it seems to be accelerating this process”, Johnston said.
One of the industry’s main interests in blockchain is to cut out middlemen when transferring money, the analyst said. Blockchain can eliminate the need for third-party verification of a transaction, along with any associated fees, making money transfer more efficient and cheaper.
Private equity in evolution
Blockchain is just one potential way for retail investors to access private equity. Sheryl Schwartz, co-founder and chief investment officer of private equity investment platform Alti, predicted it would evolve alongside alternatives, like interval funds, which offer a middle ground between liquid and illiquid investments. .
“There are over 13 million accredited investors in [the U.S.] alone, and that group of individuals will want different types of products for different reasons,” Schwartz said.
There are also risks for private equity funds leading the charge in the blockchain, which could potentially obscure the identity of investors.
“We regularly speak with top private equity managers. Many of them have very serious concerns about money laundering or know-your-customer aspects,” Pauls said.
The evolution of a secondary market for private equity tokens is also shaping up to be a big change for private equity. KKR’s deal with Securitize allows investors to sell their stake after a one-year lock-up period, for example.
Pauls said the potential for even more frequent trades would expose private equity to “the volatility and swings you see in public markets.”
“It will be a fairly new experience for the industry if all of a sudden a KKR closed-end private equity fund is priced daily, partly on sentiment and partly on supply and demand,” Paul said.