For investment funds, wealth managers and other asset managers, there’s an eternal quest for the next source of outsized returns. Whether these asset managers are overseeing client portfolios or connecting their own customers with investments directly, differentiating in the market with high-quality, high return offerings is critical.
Competition for clients is fierce, which means asset managers need new strategies to beat benchmarks and entice investors. While alternative assets can help investors attain much-needed diversification, the ingrained inefficiencies in the market can make these assets costly and difficult to manage. Now, digital securities are offering a new path forward to help both managers and their clients meet their goals.
As a digital representation of an asset, like private equity, real estate or venture capital, digital securities offer a more efficient way to access the private securities that have been building blocks of institutional portfolios for decades. These digital assets are gaining interest from institutions, with a 2019 Fidelity survey revealing that 40% of institutional investors are open to future investments using digital assets within the next five years. As the market evolves, here are four things asset managers and investors need to know about digital securities.
1. Investors are increasingly demanding new ways to outperform.
Investors look to their advisors for innovative solutions, and those who can deliver are better positioned to retain and grow their businesses. Digitally formatted investments open up an entirely new set of options for advisors to choose from, creating stronger client relationships. Four in 10 investors plan to invest digitally within the next five years, and according to the Fidelity survey, 22% are already investing digitally and 50% call digital securities innovative in general. Simply put, the demand is there.
With a market downturn potentially looming on the horizon, it’s especially important for managers to think outside the box to diversify offerings and maximize returns. While the economy, and the markets, are firing on all cylinders, geopolitical tensions, health scares, and a U.S. presidential election could all derail this bull run. Digitally formatted alternative assets can play an important role in balancing portfolios and providing additional diversification options in times of market turmoil.
2. Digital securities can create significant new efficiencies.
Transferring alternative assets like real estate and private equity has traditionally been laborious and complex. Manual, paper-based processes still plague the entire industry, which means it can take weeks for a transfer to clear and settle. The administrative burden on asset managers becomes very costly as a result, given the number of trades they place on behalf of their clients.
Using a digital format offers a much more attractive alternative to these outdated processes, helping to streamline the buying and selling of alternative assets. This emerging format not only results in significant efficiency gains, but also improves access and potential liquidity for investors. Digitization allows trades to be settled in days or even hours, instead of weeks, as more efficient, automated processes reduce the time and effort spent interacting with intermediaries. That means asset managers and their teams can spend time on more high-value tasks like collecting assets and researching investment ideas, rather than on administrative tasks and auditing investor paperwork.
3. There’s more than one way to digitize.
Security tokens represent the first wave of digitization, with an Opimas study estimating the market will reach $19 billion by 2022. As the market matures, however, providers are beginning to develop new paths to suit institutional needs.
When considering options, it’s important to know that there’s a difference between tokenization and digitization. Both streamline the manual processes used today, giving institutions a path to greater efficiency, access, and liquidity though significant increases in automation, standardization, and transaction processing speed. Digitization does so using more efficient, automated versions of required processes, is currently compatible with most legacy intermediaries and regulatory workflows, and does not require the use of blockchain. Tokenization also fully automates required processes, but with the use of decentralized ledger (blockchain) technology, it offers the potential to eliminate legacy transaction processing layers, along with any related inefficiencies and costs. The Openfinance platform is uniquely positioned to accommodate both digitization and tokenization, providing optionality in capital deployment to asset managers and their clients.
4. A growing number of institutional firms are exploring digitization.
2019 saw an acceleration in digitization, both with and without the use of blockchain. On the electronic side, issuers of institutional-grade alternatives have embraced the idea of efficiencies and the value of a robust secondary market. Additionally, intermediaries such as transfer agents and custodians see the cost savings opportunities through electronic communication with one another.
With respect to tokenization, a 2019 Deloitte survey found that blockchain was a critical priority for 53% of organizations, including major players who will have massive influence in terms of building momentum for the marketplace. Prime examples include HSBC and JPMorgan Chase’s implementation of blockchain technology over the last two years, as well as pilot blockchain projects like Franklin Templeton’s new digital money market and Santander’s digitized bond instrument.
Continued growth will hinge on the regulatory environment, however, and signs point to major regulatory decisions from the Securities and Exchange Commission in the coming year. The agency recently approved a number of Reg A+ offerings and is allowing Paxos Trust Company to work on a private blockchain project over the next 24 months, offering encouraging signs that regulations will align with market interest over time.
Digitizing with Growth In Mind
While asset managers and investors are in the early stages of exploring the efficiencies and growth made possible by the digital formatting of private securities, the entrance of a major player could ultimately create an industry-wide butterfly effect. Between rising investor demand for alternative assets, undeniable efficiency and growing interest from multiple institutions, digitized alternative assets are poised to gain momentum in 2020 and beyond.