Part One: What fund managers need to know about tokenisation

Part One: What fund managers need to know about tokenisation

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By Daron Pearce, the founder and CEO of Daron Pearce Associates

Looking back on the key developments in 2022, it is clear that whether you have concerns about innovation, regulation, or changing stakeholder roles, tokenised funds are set to transform the investment management industry and that change is coming fast.

Private market investment firms Hamilton Lane and Partners Group have already launched tokenised funds. Digital Funds recently filed to launch a tokenised S&P 500 EW Index Fund and Abrdn plans to launch a tokenised fund.

The Investment Association (IA) is lobbying for the approval of blockchain based funds. This is no surprise given that increasing investor demand for tokenised funds coincides with a time when the funds industry is seeking to boost its competitiveness in a rapidly evolving global market.

Chris Cummings, IA chief executive argues: “Greater innovation will boost the overall competitiveness of the UK funds industry and improve the cost, efficiency and quality of the investment experience.”

Nadine Chakar, until recently head of digital assets at State Street views tokenisation as a more fundamental shift, quite simply that it will “…change everything that we do.”

In this context, it is key that fund managers understand:

  • How today’s investors have changed
  • What the pace of change might look like
  • The benefits and challenges of tokenised funds
  • How to manage industry scepticism

The bottom line is that fund managers need to recognise and begin to influence those factors shaping end investor preferences, as well as the necessary investment architecture. This will enable them to lay strong foundations for their future success.

Investors have changed

Fund management operating models can be highly complex, structured around a web of intermediary relationships which stand between the fund manufacturer and the end investor. These models, perhaps designed to mitigate investment risks, have resulted in an inaccessible market that multiplies transactions and increases costs for the end investor. Such an inefficient model was immediately challenged by the blockchain vision of a peer-to-peer distributed ledger which removes multiple intermediary layers, supporting a simpler and arguably more effective model for fund governance and distribution. 

But this wholesale disruption of the traditional market is not simply down to innovations in technology. In a report earlier this year, the IA identified three societal factors driving the adoption of tokenisation in the UK fund industry:

  1. A gradual shift from ‘deference’ to ‘reference’ which could challenge the role of fund managers and see them facing increased competition to remain relevant.
  2. Hostility from millennials towards the traditional roles of capitalism: This creates opportunities for alternative or new disruptors—especially since millennials are set to inherit over £5.5 trillion in the next 20 to 30 years.
  3. New variations on the traditional understanding of investment driven by the pandemic, specifically an increase of direct investing by Gen Z (18-23), the rise of ‘amateur’ traders, alternative investing, and influencer advocated investment strategies.

Fund tokenisation is being driven by the persistent pressures of economic disruption, customer expectations, and a drive towards investment democratisation. Fund managers need to reconsider investor objectives or risk being left behind in an increasingly fast paced industry. 

The pace of change

While it is true that shifts in societal attitudes towards investment are key to the disruption of fund management, the future of tokenised funds depends on the level of technological change that the industry adopts in response to these changes.

There continues to be an increase in the pace of the move towards tokenised funds. For example, on September 13 2022, Securitize, a leading digital assets securities firm, announced the launch of a fund tokenizing an interest in KKR’s Health Care Strategic Growth Fund II (“HCSG II”) on the Avalanche public blockchain. 

John Wu, president of Ava Labs, which is part of the strategic partnership, explained that “Financial markets demand innovation, and over the last two years we’ve seen dramatic leaps forward in the evolution of real-world assets moving on-chain and delivering on the promise of breakthrough technology for institutions.”

To open up funds to a new audience of investors, leading investment firms need to form a technology strategy for fund management. But what could this vision of the future look like?

Once again, The IA has identified three possible scenarios for change:

  1. Business-as-usual enhancement: This is a more efficient version of today’s funds, which enables improved speed, scale and efficiency with new technologies. tokenisation is used to enable fund shares and underlying assets classes to be traded.
  2. Innovative evolution: This scenario uses technology to change the nature of the key stakeholders and the investment opportunity set. It supports more tailored portfolios through investor preferences and broader market access.
  3. Transformative change: Technology changes the relationship between the customer and their portfolio, so risk and return can be tailored at stock and securities level, instead of fund level. The role of the investment manager is changed as customers exercise greater control.

Whether tokenised funds will become a more efficient version of existing funds – a T share class for example – or a completely new concept depends in part on the level of participation that consumers demand.

To be continued on Wednesday January 4

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