Changing the private markets paradigm

Frank Barbarino
Director, Templum Inc

Smart securities have emerged as a timely and compelling solution for access to the growing private markets, which reached $5.8 trillion in assets under management during 20181. Capital collectively allocated to private equity (buyouts, venture, and growth), private debt, real estate, natural resources, and infrastructure is estimated to reach approximately $9.3 trillion by 20232. This trend is echoed by the shift in capital formation from public markets toward private markets- in 2017, there was $3.0 trillion raised privately versus $1.5 trillion raised publicly3.

Smart securities will create additional tailwinds to growth in private markets, which currently lack necessary infrastructure and are hampered by significant transactional frictions. The limited infrastructure that does exist around private asset liquidity is operationally inefficient and manually intensive. Furthermore, the private markets ecosystem is highly fragmented and challenged by incomplete, siloed information, and a significant degree of information asymmetries between buyers/sellers, GPs/LPs, investors/issuers, and various intermediaries.

Despite these shortcomings, institutional capital allocators (pensions, endowments, etc.) have been a driving force in the growth of private markets, seeking out the strong absolute returns of these investments to help meet their return objectives. Over the past 20 years, endowments and foundations that allocated under 5% to private, unregistered assets achieved a gross portfolio-level annual average compound return of 6.4% while those that allocated over 15% achieved 8.2%1.

Beyond the numbers, private asset investments provide myriad benefits to institutional capital allocators. They provide exposure to diversified global economic growth, high-growth companies, idiosyncratic or uncorrelated sources of alpha, and asset types not accessible through public markets. Private markets investments also give investors access to premia associated with the illiquidity, complexity, and structuring risk of private deals. Additionally, some private investments offer inflation protection while others provide a high and steady current cashflow/yield that is only modestly correlated to movements in interest rates. But liquidity is sacrificed when investing in private assets and institutional capital allocators depend on liquidity for their spending needs, capital calls, tactical allocation, and portfolio re-balancing.

Templum understands the opportunities and challenges associated with the private markets and is committed to helping institutional investors and issuers participate more efficiently. Smart securities for private asset issuances facilitated by Templum Markets in primary and secondary transactions make this possible. A smart security is simply a digital representation of a security that is tracked via a distributed ledger. Digitization eliminates transactional frictions that have hampered the private markets investment ecosystem and kept private investments from trading on active secondary markets, as information is rendered in code and enforced automatically. The use of “smart contracts” embedded in digital securities enhances the quality and speed of execution of secondary market transactions and eliminates costs, e.g., built-in transfer restrictions ease administrative burdens, cut settlement times from T+90 to potentially T+0, and reduce legal fees. Furthermore, the disclosure obligations around smart securities solve for the lack of transparency and information asymmetries among private market participants while digitization enhances liquidity and price transparency. This allows institutional investors to more effectively conduct tactical allocation and rebalancing, enhances portfolio construction, and allows for better customization of risk exposures.

  1. – Cambridge Associates, “Private Investing for Private Investors” (2018)
  2. – Preqin, “The Future of Alternatives” (2019)
  3. – SEC Division of Economic and Risk Analysis, “Capital Raising in the U.S.” (2017)

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