The official blog of BNP Paribas Asset Management

A new white paper – Tokenisation of alternative investments

Technology offers fascinating perspectives for asset management. These include tokenisation, the process of creating a digital representation of non-digital assets on a blockchain. In a new white paper, we explore the potential application of tokenisation to enable fractional ownership by investors of alternative asset classes.

Alternative investments are on the rise….

Alternative investments are attracting ever more investors. According to the Chartered Alternative Investment Analyst (CAIA) Association, between 2003 and 2018, the size of the global investment market doubled, while alternative investments almost tripled to USD 13.4 trillion. This would mean around 12% of worldwide investments were allocated to alternative investments. CAIA Association members expect this allocation to rise to 18-24% of the global asset market by 2023.

Alternative investments include investing in hedge funds, private equity, venture capital and private debt as well as real assets such as real estate, infrastructure, and natural resources.

As these asset classes are considered less liquid, less accessible and less transparent in terms of information than traditional investment assets, tokenisation[1] can be applied to them.

In this regard, tokenisation via blockchain technology could have a significant beneficial impact for investors in, and managers of, alternative assets.

Tokenisation, to broaden the potential investor base

Tokenisation could help democratise alternative investments by providing a broader range of investors with access to an asset, while enabling asset managers to innovate by creating alternative assets tokens, thereby expanding their product mix.

The tokenisation process is not a ‘one-click’ affair. It involves multiple steps: deal structuring, digitisation, primary distribution, post-token management, and certainly clear regulatory standards to enable secondary market trading.

Investor education, as always, would be crucial in making any innovation sustainable.

Source: Impact of Tokenized Assets in Business Environment

A white paper exploring the application of tokenisation

Co-authored by specialists from our digital transformation and private debt real asset teams along with CAIA and Hong Kong-based tokenisation platform Liquefy, our paper explores the application of tokenisation in enabling investors to gain fractional ownership of alternative asset classes.

Tokenisation could address some of the inherent challenges – for both investors and asset managers – of alternative asset classes by:

Improving liquidity

  • The tokens could be traded on secondary markets, improving liquidity.

Enabling faster, cheaper transactions

  • Less complexity and better operational efficiency can reduce transaction and lifetime costs, enabling faster, cheaper transactions.

Offering greater transparency

  • The token holder’s rights, legal responsibilities and record of ownership could be embedded into tokens, offering greater transparency.

Broadening access

  • Tokens would provide more investors with access to a previously unaffordable or insufficiently divisible asset classes.

Identifying the challenges

Clearly, technology will not overcome all the challenges that alternative investments may present. Creating a secondary market does not automatically result in liquidity, but we believe it is the first step. Constraints remain, for example in the area of hedge funds, private equity and natural resources where a sizeable universe of assets is needed to be able to create a portfolio of tokens for diversification.

For venture capital and private equity, tokenisation would not necessarily streamline the due diligence process as it could in the private debt and infrastructure markets.

For real estate investment, many constraints have been identified as it is currently one of the most tokenised assets among alternative asset classes. The main constraint is that real estate developers are looking into tokenisation asset by asset, so there is an issue of scalability.

For private debt, covenants could be difficult to code into smart contracts, potentially creating a challenge in the life management of the tokens. Infrastructure assets are heavily regulated, which could make it more difficult to construct a smart contract.

In addition, the benefit of greater liquidity does not outweigh the fact that alternative investments are not a silver bullet for achieving target returns. Hedge funds often rely on financial market inefficiencies to generate alpha. These inefficiencies are sometimes fleeting and often captured in part via an illiquidity premium.

Venture capital is a high-risk and high-return strategy. Investors are bound to lose money on individual deals, but they rely on the outstanding deals to generate returns such that the overall portfolio still meets the performance objective.

Private equity has huge return dispersion. The returns from the best managers and the worst managers are materially different. Real estate and private debt are characterised by information asymmetry and lack of transparency. Infrastructure and natural resources require specialised skills and scale. End-investors need to be capable of understanding and quantifying the risk they are adding to their portfolio.

Tokenisation to shape a new financial landscape?

The world faces many challenges with a huge need for capital. Estimates from the 2019 World Economic Forum suggest that to keep pace with global GDP growth, some USD 15 trillion will be needed by 2040.

Real estate accounts for one-third of global greenhouse gas emissions and consumes 40% of the world’s energy; hence, environmental upgrades could have a positive impact on our environment. The ‘New Economy’ such as space business and artificial intelligence holds great promise and requires capital from a combination of private investments, public-private collaboration and government incentives for breakthrough technology along with socio-institutional innovation.

Will traditional sources of capital suffice to provide the required funding if global debt rises to USD 277 trillion by 2020, or 365% of world GDP, because of a weaker global economy and costly pandemic relief measures?

Could tokenisation provide a bridge to a wider pool of investors and create a new source of financing for private markets such as infrastructure, real estate and private equity?

Unlocking the growing pool of retail capital could create an essential source of future funding.

Like any major disruption, tokenisation offers the scope to shape a new financial landscape, creating opportunities for both investors and asset managers. Greater access will no doubt raise the question of protection for investors. Tokenisation is still at an early stage and there is an opportunity for industry participants, product providers and regulators to collaborate and shape the outcome. This white paper is our contribution to open the debate.

Read: Tokenisation of Alternative Investments, a white paper co-authored by BNP Paribas Asset Management, Liquefy and the Chartered Alternative Investment Analyst Association

Watch the video with author Emmanuelle Pecenicic on Tokenisation of Alternative Investments

[1] The tokenization of assets refers to the process of issuing a blockchain token (specifically, a security token) that digitally represents a real tradable asset—in many ways similar to the process of securitisation. The resulting token could represent a share in a company, ownership of a piece of real estate or participation in an investment fund. Tokens can be traded on a secondary market. Source: Deloitte

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related articles

Weekly insights, straight to your inbox

A round-up of this week's key economic and market trends, and insights on what to expect going forward.

Please enter a valid email
Please check the boxes below to subscribe