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Private equity's blockchain adoption may clear path to retail investors


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Private equity's blockchain adoption may clear path to retail investors

Private equity's adoption of blockchain technology is accelerating as the asset class increasingly sees it as a pathway to access the trillions of dollars in investable capital held by the wealthy around the globe.

Market leaders Hamilton Lane Inc., KKR & Co. Inc. and Partners Group Holding AG have recently entered into blockchain partnerships with technology companies, setting the stage for what could be the democratization of private markets.

Blockchain is a financial infrastructure or a "digital ledger" that allows for, among other things, the tokenization of funds. Tokenization involves dividing a fund stake into digitalized fractions, which facilitates smaller investments that are easier to trade.

The technology broadens the investor base for private equity, which is now mostly limited to institutional investors and high- and ultra-high-net-worth individuals who can afford investment minimums that often start at millions of dollars.

Outside that limited circle of private equity investors is the global mass affluent, a group estimated to hold $80 trillion in investable capital. But in the world of private equity, where investors often meet in person with fund managers before making their commitments, going after that capital has not been worth the effort and expense.

Blockchain adoption aims to change that dynamic by making it easier and cheaper for individuals to tap into private equity funds.

Big firm interest

Blockchain has attracted the larger private equity firms, suggesting peers are likely to follow as competition for investor capital heats up. 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 securities exchange that carried out the tokenization.

Hamilton Lane followed suit in March, partnering with ADDX to tokenize one of its funds. Since then, Hamilton Lane has announced plans to work with digital securities platform Securitize Inc. to create tokenized feeder funds for three separate funds.

In September, KKR partnered with Securitize to tokenize an interest in the firm's $4 billion KKR Health Care Strategic Growth Fund II SCSp. At the time, Dan Parant, managing director and co-head of U.S. private wealth at KKR, touted blockchain's potential to open private equity "to a new audience of investors."

For now, there are limitations on just how large that audience can grow. Tokenized funds are well-suited for retail investors, but U.S. federal securities laws still restrict the asset class to affluent investors who meet comparatively high wealth and income minimums.

There are also technical challenges. Steffen Pauls, founder and CEO of the digital investing platform Moonfare GmbH, which has $150 million in assets under management from U.S. investors, said blockchain has not yet been used to manage capital calls, when private equity fund managers call on investors to deliver the capital they have previously committed to a private equity fund.

"Currently, I think everyone is in exploration mode," Pauls said. "The development is still very nascent."

Finance dives in

Access to both funds is still restricted to accredited, non-U.S. investors. But tokenization allowed Partners Group and Hamilton Lane to lower the minimum buy-in for the funds to a ticket size of $10,000. In the case of the Hamilton Lane fund, that is down from a previous minimum of $125,000, according to the firm.

Private equity may be in the early days of its experimentation with blockchain, but adoption is spreading across the financial industry, according to 451 Research analyst Alex Johnston, who tracks developments in data, artificial intelligence and analytics. The finance sector has been among the fastest to adopt blockchain technology, with close to a third of firms in a recent survey telling 451 they are already putting the technology to work.

"Finance is not only already the most mature industry, it seems to be speeding up that process," Johnston said.

One of the industry's main interests in blockchain is removing middlemen when moving money around, the analyst said. Blockchain can eliminate the need for third-party verification of a transaction, as well as any associated fees, making it more efficient and cheaper to move money.

Evolving private equity

Blockchain is just one potential route for retail investors to access private equity. Sheryl Schwartz, co-founder and chief investment officer for 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 risks, too, for the private equity funds that lead the charge into blockchain, which could potentially obscure the identities of investors.

"We talk to the largest private equity managers out there on a regular basis. Many of them have very deep concerns around money laundering or the know-your-customer aspects," Pauls said.

The evolution of a secondaries market for private fund tokens also stands to be a big change for private equity. KKR's deal with Securitize allows investors to sell their interest after a one-year lockup period, for instance.

Pauls said the potential for even more frequent trading would expose private equity to the "volatility and fluctuations that you see in public markets."

"It will be quite a new experience for the industry if suddenly a closed-end private equity fund from KKR is priced on a daily basis, partially on sentiment and on supply and demand," Pauls said.