Openfinance Insights

While investors know that diversification is key in any portfolio, investing in private and non-listed securities has historically been easier said than done. Accessing deals is often challenging, buying a stake requires significant amounts of capital, and liquidating a position is all but impossible for investors.

At Facebook’s annual F8 conference earlier this year, Mark Zuckerberg declared “the future is private” – but is that the case when it comes to investments?

Diversification. Capital appreciation. Protection from inflation. Real estate offers a slew of advantages that make it a natural fit for many investment portfolios. Since these assets aren’t typically tied to daily market ups and downs, investors often incorporate them alongside equities and fixed income. As part of a diversified portfolio, real estate can offer a more stable, long-term investment with the potential to grow in value and produce income, in some cases.

Over the last several years, peer-to-peer payment apps like Venmo and Zelle have made it exponentially easier to transfer money among friends and family. While paying for your share of dinner or the gas bill once required visiting an ATM to get cash or writing a check that took days to clear, it’s now simple to settle tabs instantly with a few taps of a screen.

For sophisticated investors willing to take calculated risks, hedge funds can offer an attractive way to earn active returns while diversifying their portfolios. According to the SEC, there are currently over 9,000 hedge funds worldwide managing $3.6 trillion in assets. These funds pool resources from multiple investors to invest in a variety of related strategies, often betting that one security or sector will rise as another decreases in value. Getting both parts of the strategy right can lead to above-average returns for both the fund and its investors.

What’s in a name? Quite a bit, when it comes to investing.

As the market for digitally formatted securities continues to grow, participants and observers are bandying around terms like “security token,” “digital security” and “crypto asset” to describe what’s happening in the space. That litany of descriptions can be confusing for both investors and issuers as they consider opportunities across the market.

For many up-and-coming businesses, venture capital funding can make the difference between sustainable growth and shutting the doors. Venture capital is a critical resource for early-stage companies, while investors willing to take a chance on these businesses can potentially reap above-average returns. As the startup ecosystem continues to grow, venture capital investment surged to a record-breaking $131 billion in the U.S. last year, with 2019 off to a similar pace.  

“Are digital securities another questionable crypto investment?” “Can I invest if I’m not accredited?” “What do these assets have to do with blockchain, anyway?”

For participants across the alternative asset industry, the rise of digital securities is poised to deliver what’s long been missing from the private securities market: liquidity.

Potentially higher valuations. Lower capital costs. Fewer administrative hassles. As the digital securities market continues to grow, more issuers are investigating the benefits of digitizing their listings.

Digitization makes perfect sense for issuers in the $8.8 trillion alternative asset space, where inherent inefficiencies have prevented both issuers and investors from realizing the market’s full value. The industry’s paper-intensive, manual and redundant processes have remained largely unchanged for decades, making it nearly impossible to buy and sell assets on the secondary market and ultimately depressing valuations for issuers.

Digital securities offer an efficient, modern alternative, enabling investors to buy and sell smaller stakes electronically in assets like real estate, private equity, and venture capital. For issuers, this approach can help them reach a broader market, boost valuations and streamline administration, all while meeting regulatory requirements. But while digital securities are a natural fit for most alternative assets, they’re not the answer for every situation. For issuers interested in the advantages of digital, here are three good reasons to pursue a digital listing.

1. Expanding access to more investors

For the most part, issuances in the private securities industry happen behind closed doors. Companies typically offer ownership in a real estate project or an up-and-coming startup to a select group of investors, shutting out those who don’t have an inside connection to the deal. Even if these investors knew the right people, most can’t come up with the capital to invest, with minimum investments often starting at $50,000 or higher.

Digital securities democratize this process by allowing investors to take part in deals that were once out of reach. More efficient distribution enables investors around the globe to buy and sell securities more easily, and a secondary trading market expands the number of people who can potentially own these assets. By breaking up larger assets into bite-sized units, digital securities also allow issuers to take on smaller investors more efficiently. While an investor might have once needed $100,000 to invest in a traditional real estate project, they might now be able to own part of the same deal for just $5,000.

For easily accessible assets like public equities, the benefits of enhanced access that comes from digitizing may not be meaningful, but for assets where investor access has traditionally been limited, like private securities, a digital approach can help issuers reach a broader pool of interested investors and achieve the liquidity that can lead to higher valuations.

2. Improving transparency to help investors make more informed decisions

Understanding private security performance can be a mystery for investors, thanks in part to infrequent business updates. For securities like REITs or venture funds that include multiple holdings, performance data on individual holdings is also often scarce. This lack of data often makes it difficult for investors to research and build a healthy, well-diversified portfolio.

Digital securities offer more transparency to investors by enabling them to see real-time market pricing, data that’s never been available for most of these these assets before. Based on each asset’s performance, investors can vet current and potential holdings to create a portfolio based on their individual needs. Since asset entry sizes are smaller, investors can also select assets based on the specific markets and properties they’re interested in. For example, rather than investing in a single REIT, an investor could spread a similar amount of funds among investments across multiple areas of the REIT market. This transparency also benefits issuers, who can use it as a key selling point to generate investor interest among those uncomfortable with less transparent products.

3. Increasing flexibility for investors

Traditionally, investing in an asset like venture capital or private equity often meant tying up capital for anywhere from seven to 10 years. If an investor needed to liquidate, they typically had to take a large discount — if they could find a buyer at all.

Thanks to their smaller increments and a secondary trading market, digital securities give investors more flexibility to buy and sell assets as their needs change. And while clearing and settlement can take weeks to complete with traditional private securities, the digital format offers cost-effective, frictionless transfer with near-instant settlement. For private securities issuers, these advantages can help improve investor satisfaction, keep them coming back for new offerings and boost asset valuations.

While digital securities can help facilitate liquidity, however, they don’t guarantee it. As the market matures, truly unlocking the value of digital securities will require a robust ecosystem of platforms and providers like Openfinance. For issuers whose goals align with the advantages of digital securities, the potential to transform their businesses is great.

Originally posted on medium.com