By Joanne Murphy, Managing Director, APAC, CAIA Association and Wu Guowei Jack, CFA, Director, Content APAC, CAIA Association
Retail investors increasingly understand the risk profile associated with alternative investments and are interested in actively allocating to them. They are also more willing to lock up their capital for the longer term. However, the reality is that, generally, only accredited investors are allowed access to these investments, leaving retail investors with no entry point. Essentially, access to alternative investments depends on the individual’s net worth, and with the current level of net worth required, retail investors generally miss out.
New product solutions are being designed to help bridge this gap. One recent product innovation is tokenization, which we feel has the potential to be a significant tool to widen access to investments that were previously off limits.
Tokenisation is the digitalisation of an asset using blockchain technology. The underlying asset could be a traditional asset class (like a stock or a bond) or an alternative asset class investment (like private equity or real estate). Generally, assets that are less liquid, less accessible, and less transparent in information are more feasible for tokenization. These assets tend to have higher associated investment costs due to increased due diligence and time costs associated with them due to their greater complexity.
To better understand the topic of tokenisation, we partnered with Liquefy, a leading tokenisation solutions expert, and BNP Paribas Asset Management, one of the world’s largest asset managers, in a white paper on Tokenisation of Alternative Investments. Our aim was to explore the application of tokenisation across the broad spectrum of alternative investments. We also identified the benefits and the challenges of applying tokenisation in each of the alternative asset classes. The white paper can be found at this link.
A key benefit of tokenisation is fractionalization. This allows for the ownership of an underlying asset to be split across many investors. Each investor then benefits according to the proportion that they own. Fractionalisation allows for previously high-ticket investments to be portioned into much more accessible ticket sizes. For example, retail investors will no longer need at least US$1 million to invest into, say, a private equity investment; instead, one could invest with just US$100k or even lower. That’s a 10x reduction in investment cost and a 10x increase in accessibility! Tokenisation provides a solid enabler for investors to invest according to the size of their portfolio and their net worth, versus the minimum investment required.
This path provides retail investors access to investments that were previously available only to sovereign wealth funds, pensions, endowments, and other institutional or high-net-worth (HNW) investors. It could also open up access to top-tier managers for smaller institutional investors, as cheque size will no longer be a determinant of whether it is worthwhile for top-tier General Partners to invest their time on the potential Limited Partners.
In addition, there are other potential benefits such as more efficient processes and lowering of administrative cost which bode favourably to all investors.
While tokenisation may create a secondary market for alternative investments, it does not automatically result in liquidity being available. In addition, gaining access to alternative investments, which could potentially enhance portfolio returns, does not ensure investors will meet their target returns. Investors need to be capable of understanding the different risk profiles of alternative investments and the risk that they are adding to their portfolio.
POTENTIAL OF TOKENISATION
A good example to help us imagine the potential for tokenisation is the history and evolution of real estate investment trusts (REITs). A key benefit of a REIT is its ability to provide for wider investor access to commercial real estate. Previously, only large developers and large enterprises have been able to own commercial real estate. Now, all classes of investors—institutional, HNW, or retail—can access commercial real estate through the utilization of a REIT structure.
Another key benefit of a REIT is the ability to diversify via fractional ownership. With a REIT, investors can have fractional ownership to a portfolio of commercial real estate. Investors do not need to own individual buildings, which may require both a large ticket commitment as well as present an investment too concentrated for their portfolio. Without the availability of a REIT, a retail investor wishing to hold real estate would probably choose to buy residential real estate or perhaps small-ticket commercial real estate.
If all retail money is chasing the same type of investments, does it lead to a dangerous and volatile market? With a REIT, investors now have greater options, and they can decide which market offers better investment opportunities. The outcome is that the overall system is better off.
Tokenisation brings this concept of fractional ownership one step further. Tokens can be created either on a portfolio of real estate or individual real estate. In a tokenized world, investors could trade away tokens when they want to reduce exposure to certain type of property, or they could buy more tokens when they want to increase exposure. They could thus create their customized portfolio of fractional interests in real estate that could provide a more targeted exposure. This contrasts with REITs, which sometimes still have lumpy exposure to a certain geography or sector because they are often a bundle of commercial real estate.
Tokenisation is not without its challenges. There are many questions to be addressed, and these are different for each participant. For the end investors, they will no doubt ask whether only lower-grade alternative investments will be packaged into tokens—leaving the higher-grade products for the larger ticket writer? Will there be sufficient liquidity in this token should I need to sell? A possible way could be to limit tokenisation to funds where managers have a demonstrated positive track record.
For fund managers, the opportunities to widen their reach to a more diverse investor base are appetizing. Tokenisation certainly shows promise as an efficient way to manage large numbers of investors, which previously would have been costly and effort-intensive.
For the regulators, tokenisation development will create new challenges, particularly in relation to how they can effectively regulate without hindering market developments. Furthermore, they will need to think about how they protect the most vulnerable of investors.
This space is still in its early days and developments are continually evolving. We encourage all stakeholders—allocators, fund managers, regulators, and supporting intermediaries—to participate in this discussion. To this point, we’d love to hear your thoughts and ideas!
Visit CAIA's The Tokenisation of Alternative Investments research page to access the paper and for more resources on this topic.