Ever wonder what type of tokenized product will still be an attractive investment in the near future? Tokenizing an early stage seed round has benefits in and of itself? Unfortunately, there is also a disadvantage too, there is a high probability that the company will not exist in 7 years.

However, there are a few types of investment products that provide lower risk profiles and can utilize tokenization to offer improved liquidity for primary investors and also a strong investment opportunity to new investors within 5 years.

This article will aim at exploring the idea of improved liquidity for tokenized LP interests in private equity funds. It will try to assess, explore and show PE’s attractiveness, and risk profile, as an investment product both in the primary and the secondary market.

Private equity managers continue to raise record amounts of capital and institutional investors (pensions, endowments, UHNWI) continue to allocate capital to private equity. But, why so? Because of the private equity asset classes’ long-standing capability to generate or create alpha. According to a report by McKinsey “almost 90 percent of LPs said recently that private equity (PE), the largest private asset class, will continue to outperform public markets.”

However, this advantage in performance also comes at a cost, your investment is illiquid. Investors generally expect to lock up their capital for the long term, say for like 10 years in exchange for the potential of higher returns.

As private markets have grown, it’s clearly visible that not all investors can bear this illiquidity for the full lifetime of the fund. Today it is getting more popular for LPs to sell assets before the agreed fund term (around years 5–8) to realize gains and make adjustments to their existing portfolios. This demand for liquidity before the fund term ends leads to the creation of the secondaries market.

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The problem with today’s secondaries market

These days LPs have the ability to instigate the majority of the secondary market discussions. They want to secure their returns earlier as a portfolio management tool. However, nearly almost all of the successful secondaries transactions involve the selling investor to work closely with the GP during the sales process. This is because under the majority of fund agreements and contracts require the consent of the GP in order to transfer the interests in the fund.

Due to the requirement for the participation of the GP, the GP has the power to refuse to transfer fund interests without reason. Furthermore, GPs generally look forward to being remunerated for fulfilling their role in the transfer process. This fee is mostly shared between the buyer/seller.

Moreover, GPs also have a variety of restrictions in place in terms of when they will consent to a transfer of interests (quarterly, bi-annually, tax-related transfer restrictions).

The blockchain solution

As we can see from Coller Capital’s image, we have already seen the secondaries market grow in response to increasing liquidity needs. The next stage of this development could be fueled by GPs who opt to issue part of their primary fundraise via tokenized feeder funds. These feeder funds will be accounted for as a single LP to the GP, but can allow for secondaries market that does not require the direct involvement of the GP. This could lead to the creation secondaries market opportunity for smaller investors.

Smaller investors require access to private investment opportunities which the sophisticated investors would also find appealing. Looking forward — there is little doubt that the private equity secondaries market will continue to grow. The question is, will blockchain technology be used to help fuel this growth and provide smaller investors access?