Private equity’s blockchain adoption could clear the way for retail investors

Private equity’s use of blockchain technology is accelerating as the asset class increasingly sees it as a way to access the trillions of dollars in investable capital held by the wealthy worldwide.

Market leaders Hamilton Lane Inc., KKR & Co. Inc. and Partners Group Holding AG has 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” which, among other things, allows for the tokenization of funds. Tokenization involves dividing a fund share into digitized fractions, which facilitates smaller investments that are easier to trade.

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

Beyond the limited circle of private equity investors is the global super-rich, a group estimated to hold $80 trillion in investable capital. But in the world of private equity, where investors often meet fund managers in person before committing, 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 tap into private equity funds.

Great great interest

Blockchain has attracted the larger private equity firms, suggesting peers are likely to follow suit as competition for investor capital increases. In September 2021, Partners Group 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 performed 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 US private wealth at KKR, touted blockchain’s potential to open up private equity “to a new audience of investors.”

Currently, there are limits to how large the audience can grow. Tokenized funds are well-suited for retail investors, but US federal securities laws still limit the asset class to wealthy investors who meet relatively high asset and income minimums.

There are also technical challenges. Steffen Pauls, founder and CEO of digital investment platform Moonfare GmbH, which has $150 million in assets under management from US investors, said blockchain has yet to be used to manage capital calls, when private equity fund managers ask investors to deliver the capital. they have previously committed to a private equity fund.

“For now, I think everyone is in search mode,” Pauls said. “Development is still very nascent.”

Economics dives in

Access to both funds remains restricted to accredited, non-US 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’s down from a previous minimum of $125,000, according to the firm.

Private equity may be in the early days of experimenting 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 financial sector has been among the fastest to adopt blockchain technology, with close to a third of businesses in a recent survey telling 451 they are already putting the technology to work.

“Finance is not only already the most mature industry, it appears to be accelerating that process,” Johnston so.

One of the industry’s main interests in blockchain is to remove 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.

Private equity in development

Blockchain is just one potential route 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, such as interval funds, which offer a middle ground between liquid and illiquid investments.

“There are over 13 million accredited investors in the [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 the private equity funds that lead the charge into the blockchain, which could potentially hide the identity of investors.

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

The development of a secondary market for private fund tokens is also a big change for private equity. KKR’s agreement with Securitize enables investors to sell their interests after a one-year lock-up period, for example.

Pauls said the potential for even more frequent trading would expose private equity to “the volatility and swings 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, partly on sentiment and on supply and demand,” Paul’s so.