How Private Equity can make mainstream investors feel more welcome

Up until the recent past 5yrs or so, private equity investing was limited to institutional, professional, and sophisticated investors. Thanks to positive tailwinds, such as regulatory changes amongst others, private equity opportunities are now available to a wider market mainly through access funds and ‘crowd’ platforms. One of the major developments that have supported traditional investors is the existence of a secondary market, which allow investors to sell their holdings ahead of the end of the illiquid asset / fund life to satisfy a variety of needs, chief of which are:

- the opportunity to diversify a portfolio by changing up or down an original investment to include new opportunities made possible by market environment.

- Reduce the length of time across that overall capital is kept under water.

- Take advantage of an asset made available at relatively attractive pricing, and / or

- Increase the pace at which one receives capital invested.

And other more individual reasons.

The existence of such a market since introduced in 1985, has supported fresh capital investment activities (primary) very well. However, access to the current $40bn private markets secondary markets is limited to the traditional investors (principally, pension funds, large family offices, private market managers, venture funds) where transaction volume ($m) is paramount.

As positive tailwinds support democratisation of private assets and capital managers (private banks, wealth managers, multifamily offices) along with crowd platforms have made primary access to private assets (typically private equity and venture opportunities) possible with lower investment levels. The next level of innovation is to make the current secondary markets for private assets accessible and effective through the power of blockchain and AI.

Private Asset Securitised Token Offering (PASTO) is a long overdue solution needed to support the democratisation of private markets as private markets extend from institutional investors to mainstream thanks to positive regulatory changes and market forces. As a mechanism to securitise investor interests, PASTOs have extensive use cases, with one such application in private assets secondary market without the loss of the underlying characteristics and benefits of the private assets.

And so, what are PASTOs?

PASTOs are essentially frictionless representations of investment interests in private market funds, private companies and other illiquid assets. It allows for existing (or new) investment interests to be transformed into digital formats like for like the physical investment such that the initial value of a PASTO is exactly the same as the value of the investment interest at the time of issuance of the PASTO. In a way, PASTOs are a variation of stablecoins at creation but are not currencies. It borrows the characteristics of stablecoins[1] and creates a mechanism for storing, transferring, transmitting, and exchanging the underlying value of the interest held in a private / illiquid asset, which are all key activities necessary for an effective secondary market to operate. Like the creation of stablecoins, PASTOs are created within a secured cryptographically enabled distributed ledger environment. Let us now explore why PASTOs are revolutionary.

Storing:As a mechanism to store private market / illiquid assets investor interest, digitising the investor interest, which is usually held in hard copy, places private markets investing on trend. An investor with a PASTO has a digital representation of their physical interest securely stored. As a store of value of the underlying investment the applied use cases are extensive including enabling and making secondary markets accessible.

[1] For recognised definition of stable coins, see the Office of Comptroller of the Currency https://www.occ.treas.gov/news-issuances/news-releases/2021/nr-occ-2021-2a.pdf

Transferring:

PASTOs are created within a secured cryptographic distributed ledger environment connected to traditional financial systems through the use of oracles. Oracles behave in a similar way as APIs and allows technology systems to talk to each other with ease. Another way to think of oracles would be to look at how a kitchen sink bowl connects to the mains — an oracle will act in a similar way as the tube that connects the sink bowl (traditional financial system that stores the information concerning the private asset fund / company / illiquid asset) to the main system (the cryptographically secured distributed ledger environment a.k.a blockchain).

Transmitting:

With the underlying private asset transformed to a digital asset, transmitting information about the underlying portfolio happens in real time for the investor in such a way that whenever the underlying operator of the underlying private asset (private fund manager, private company management etc) updates information on the underlying asset, the investor also receives this in real time. Typically, reporting is lagged for the investor of a privately held /illiquid asset. The operator values the asset (which in itself takes some time to do especially if there are a lot of assets to value), sends report in hard copy format (pdf these days) to the investor. Investor then reports in sentences and graphs usually with no continuity to previous reports. As a PASTO, the continuity to information can occur and be streamlined effectively as data is chain linked and can be recalled for purpose.

Exchanging of value:

The design of PASTOs as a digital representation of the underlying private asset and the investor interest has great value and numerous use cases. As an enabler of an accessible secondary market, it allows for the exchange of value to occur rather seamlessly. The primary PASTO essentially stores the value of the underlying private / illiquid asset and moves in line and in step with the underlying asset. In secondary state, i.e., when the holder is ready to sell her interest on to a new buyer, exchanging that value to a new buyer occurs seamlessly given the properties of the PASTO and allows for both the buyer and seller to incorporate their expected value of the underlying asset into the presented value of the PASTO and turning the presented value to a deal price effectively. For further background discussion, see the preliminary paper[1] from the author. The seamless transitioning of PASTO value to PASTO deal pricing is further enabled if the environment has an AI service to support the deal price estimation for both the seller and the buyer.

Who designs PASTOs and oversee the operation of PASTOs?

The main purpose of digitising private assets through the issuance of tokens is to support the democratisation of private markets with use cases that includes making secondary markets effective for incumbents and accessible to the emerging mainstream buyers of private and illiquid assets.

The design of PASTOs is a consensus activity that includes the usual participants of a private asset investment specifically private capital funds, conduits (private banks, crowdfunding platforms, family offices, wealth managers) and fintech. Currently conduits of capital (particularly private banks, wealth managers, certain platforms) have made tremendous efforts in making private asset funds accessible by creating access funds which subsequently invest in the main funds. The next step here is working with fintech companies that understand the convergence of AI and blockchain technologies to evolve access.

[1] The Future is Now: A marriage of novel technologies and traditional financial infrastructure for the democratization of privately held assets by Lydia Ofori, CFA, CAIA. Accessible via www.hunter-labs.io/whitepaper

In such a scenario, a private bank, a wealth management platform, a multifamily office who have created the access fund, working with the fintech, transforms the said access fund into a PASTO with the value of the PASTO determined by the enterprise. For example, if the capital manager created a $100m access fund which subsequently invests in a main fund, working in tandem with the fintech, they can determine that the value of a unit of a PASTO to be the following:

$100m Access Fund ABC; unit value, $50k = $100m PASTO Access Fund ABC; unit value, $50k

where unit value equals the minimum investment for the Access Fund ABC.

An investor with $100k invested in Access Fund ABC then holds 2 PASTOs for Access Fund ABC

Client X LP interest in Access Fund ABC; value, $100k = 2 PASTO Access Fund ABC;

As above, the said investor holds both the physical limited partnership agreement document (LPA) and the PASTO in their wallet.

Whilst in primary state, meaning the investor has no interest in selling their investment, the whole ecosystem — investor, the capital manager, the private equity fund manager — have beneficial advantages. The capital manager has a digital representation of not only the underlying portfolio but has provided their client with an on-trend version of their interest as well. Reporting and transmitting of information about their portfolio happens in real time for the investor as the capital manager reports on the fund. However, the insights provided to the investor goes even more deeply especially if an AI service is enabled on the capital manager’s platform. In secondary state, i.e., when it makes sense for the investor to sell their interest, as a tokenised asset, the onward sale occurs seamlessly given the characteristics of the PASTO. If enabled within a marketplace that has an embedded AI service, the determination of the deal price for the PASTO is supported by fundamentals specific to the underlying asset and to that specific market dynamics.

For the private equity manager working with the capital manager and the fintech, the transformation of access funds into PASTOs brings further innovation to the private equity firm, placing such firm on trend, helping the said firm and their funds to supplying solutions that investors are looking for today[1].

PASTOs are revolutionary. In the discussed use case as a mechanism to further unlock current secondary markets and to make secondary markets accessible to non-traditional investors, it has the potential to extend the emerging $6trillion[2] wealth market for private market operators. Giving non-traditional investors similar benefits such as the opportunity to take advantage of emerging themes or exiting primary investments within a shorter time frame (3–4 yrs. vs full 10years of the fund) for example will be a strong positive signal for the emerging buyer group.

[1] See Morgan Stanley / Oliver Wyman BluePaper, Global Wealth Management 2020

[2] See Preqin