By ADDX

This research is commissioned by ADDX in collaboration with Zero One, an insight provider on SmartKarma.

Executive Summary:

Private markets represent under-tapped opportunities. Today, many of the most attractive investment opportunities lie in the private markets. Despite that, most individual investors have little to no exposure to private asset classes, choosing instead to focus on the public markets.

Private markets generate higher returns than public markets. Over the last 10 years, global private equity has yielded an average annual return of 14.2% versus global public equities at 10.0%. Early-stage venture capital has generated higher returns of 16.3% versus the S&P 500 at 14.0%. Private debt markets also yield higher returns (10.6% from 2014-19) compared to public debt markets (10-year historical return of 4.1%).

Blockchain is democratizing access to private investment opportunities. Through a process called tokenization, previously illiquid assets across equities, debt, and real estate can now be broken down into smaller pieces and traded far more efficiently. This is dramatically lowering the cost and diversification barriers to allocating more capital towards private investment opportunities.

Digital exchanges offer private investors multiple advantages. Digital exchanges such as ADDX can offer investors the ability to access multiple asset classes in a single portal, direct market access to private investment opportunities that help cut fees, faster settlement times, and a more convenient KYC/ AML process.

Private Markets: Offering Higher Returns and Differentiated Investment Opportunities

Managing investments is one of the most critical aspects of building, maintaining, and growing wealth. Thus, depending on the investor’s risk profile and target returns, it is important to design an investment strategy that appropriately allocates and diversifies across multiple asset classes.

Despite this well-understood adage, most individual investors remain heavily focused on the public equity and public debt markets with often little to no exposure to the private markets. This is due to a variety of factors including lack of access to private opportunities, high minimum investment sizes, regulatory accreditation requirements, and a lack of understanding.

This is a shame, given that many of the most attractive opportunities today lie in the private markets. As seen in the chart below, over the last 10 years, private equities provided higher returns both globally (14.2%) and in the USA (15.6%) than global public equity (10.0%) and US public equity (14.2%). This is according to benchmark data compiled by Cambridge Associates.

This trend extends beyond equities too. Private debt, for example, yielded an average annual return of 10.6% from 2014 to 2019 versus the 10-year average historical return of public bonds at 4.1%.

Source: Cambridge Associates Index and Selected Benchmark Statistics (June 2020), Bloomberg, Zero One

One of the reasons for the higher returns of the private market can potentially be attributed to its relatively untapped nature. Compared to the public markets that are already extremely efficient due to their many mechanisms and participants in place, the private markets remain relatively under-tapped by investors which means less competition for attractive investment opportunities.

For example, in venture capital (where many of the most innovative and disruptive businesses are), most of the startups remain cash-strapped and starved for capital. This provides venture capital investors, especially in earlier stages, more negotiating power to invest at significantly lower valuations. For reference, early-stage VCs in the United States have generated an average annual return of 16.3% over the last 10 years – higher than both the S&P 500 index at 14% and the Russell 2000 index at 10.5%.

A similar story can be found in the private debt markets where SMEs with strong business models are often denied term loans or working capital financing simply because they do not meet the rigid collateral or financial history requirements of banks. Investors are thus able to charge much higher interest rates in the private market that would not have been possible in the public debt market due to the ease of funding there. For example, between 2014 to 2019, non-bank private lenders generated an average annual return of 10.6% versus the 10-year annualized return of 4.1% for public bonds.

We highlight some key differences between public and private markets in the table below:

Types of Private Market Opportunities: Equity, Debt, and Real Estate

Blockchain is Rapidly Democratizing Access to Private Investments. Access to private market opportunities is rapidly being democratized today with the rapid adoption of blockchain technology. Through the process of tokenization (the act of issuing a digital token that represents and has a claim to the underlying asset), previously large or illiquid assets can be broken up into smaller pieces and transacted upon on the blockchain.

This is not dissimilar to how shares of public companies currently trade on exchanges. The difference however lies in the flexibility on what assets can be tokenized, the degree to which they can be fractionalized into smaller pieces, and how fast or efficiently they can be processed and transferred.

By leveraging tokenization, previously illiquid assets such as real estate can be denominated into far smaller increments of $10,000 per token, for example. The same can be said for private startups, mid-market bond issuances, public equities (e.g. $100 tokens of AMZN instead of $3000 per share), and even claims to certain cashflows or revenue share agreements.

Source: Finoa, World Economic Forum, Deloitte, BCG, Oliver Wyman, Zero One

We elaborate more on the different types of private market opportunities available to investors below.

Venture Capital & Private Equity: More Access and Faster Exits for Investors

Venture capital (“VC”) and private equity (“PE”) investing refer to the act of taking positions or allocating funds to companies that are not listed on any public stock exchange. The difference is that venture capital tends to start at the earlier stages (raising capital for new disruptive businesses across seed-stage and Series A to E) whereas private equity tends to focus more on larger more established companies.

As discussed in the previous section, both VC and PE industries have historically generated higher returns than their public equity counterparts. Over the last 10 years, global private equity has returned 14.2% versus global public equities at 10.0%. Earlier stage investments in US venture capital have also outperformed at 16.3% versus S&P 500 at 14.0%.

Historically, investing in VC and PE was a difficult process as one needed to be a very high net worth individual or an institutional investor (such as family offices). This barred out the majority of investors from accessing these private market opportunities. Even for some lower-level accredited investors (with liquid assets of ~$2-3 million), many would not be able to access these opportunities given the large minimum commitments.

On the other hand, for investors that would rather opt to invest in private companies directly, it was often a challenging process given that there are lower disclosure, reporting, and auditing requirements for private companies. Exiting or liquidating the investment was also a major challenge given that one needed a liquidity event such as an acquisition or an IPO to get back their investment.

This is all changing with the application of blockchain technology to the VC and PE sectors. By tokenizing shares in private companies, even smaller accredited investors will be able to access these opportunities. For existing investors in private companies, the tokenization of private companies also offers them the opportunity to easily and cheaply liquidate and exit their investments even without an IPO or acquisition.

Source: Preqin, Zero One

Private Debt: More Transparency and Lower Investment Sizes

In contrast to public companies that can easily raise debt financing by issuing bonds that are rated by credit agencies and then subsequently distributed by banks, private debt refers to debt issued by SMEs or midmarket companies that typically struggle to raise financing from traditional bank sources. This can be due to a lack of financial history or the unavailability of collateral. This stringent process of banks cuts off many promising companies – especially software companies that naturally do not hold significant amounts of tangible or fixed assets.

Due to the difficulty of accessing financing for these private companies, they are often more willing to pay higher interest rates. For reference, Funding Society (a Southeast Asian P2P platform) cites on their website that private debt can yield interest rates of up to 18% per annum. Non-bank lenders managing their own loan books to private companies have also historically generated higher returns at 10.6% per annum – higher than the 10-year historical return of public bonds at 4.1%.

Blockchain can take an active and impactful role in this space as well. Beyond tokenizing private bonds into smaller increments, blockchain can also increase transparency, ensure compliance with covenants, and enforce proper and timely disbursement of interest payments. This is through the use of smart contracts that can be programmed to automatically take certain actions assuming certain conditions have been met.

Source: Preqin, Zero One

Real Estate: More Diversification and Bypassing Intermediaries

To get exposure to the real estate market, most investors currently do it in three ways:

1.Get a mortgage

The most traditional way to get exposure to the real estate market is simply by purchasing the property outright. This can be tricky to manage however given that many properties can be north of $1,000,000 making diversification difficult and requiring the usage of loans to finance the purchase.

2. Stocks of property developers

Alternatively investors could also gain exposure by purchasing the shares of property developers. This is a far more cost-effective way of gaining exposure, however, it is also relatively indirect as it is dependent on the skill of the real estate developers to consistently build and sell attractive properties.

3. REITs

REITs or real estate investment trusts are another popular way to get access to the property market. REITs allow investors to get the rental cashflows associated with certain properties. These can be residential, office, commercial, or even focused on certain types of assets (e.g. data-center focused REITs). However, just as with property developers, investors are still dependent on the skill of the REIT managers to properly choose and manage the said properties.

With blockchain, investors will be able to bypass intermediaries like property developers and REIT managers and gain direct access and exposure to real estate assets. This is akin to owning the property yourself. The difference is that by purchasing tokens of properties, investors can better diversify across multiple types of properties given that investment sizes can be as low as $10,000 per property token.

Liquidity is also significantly easier to manage given that investors no longer need to pay expensive fees to property agents to market and sell their properties. Investors will have the option to simply sell tokens of their properties on digital asset exchanges.

Source: Preqin, Zero One

Digital Exchanges: The Smarter Way to Access Private Market Opportunities

Given the numerous opportunities in the private market that are being democratized by blockchain technology, digital asset exchanges represent a smart way to access them. Compared to traditional exchanges that remain reliant on legacy technology infrastructure and manual & paper-based processes, digital exchanges can automate many key processes which enable faster, cheaper, and more efficient services overall. We highlight four key advantages of using digital exchanges below:

1.Multi-Asset Class

Investors can invest and trade across multiple different asset classes via tokens that represent the underlying asset. By conducting all transactions in a single place, investors can have a more holistic view of all their allocations and positions across different asset classes. This is significantly better than the current environment of managing different types of investments across multiple different platforms which can make it difficult to have a full top-down picture.

2. Faster Trade Settlement: Real-time ownership and trade data on who owns what via a blockchain-powered share registry can also help speed up several key processes given that timely and accurate information can be accessed at any time. For example, trade settlements can theoretically become near-instantaneous in a decentralized finance setting vs. the 2-5 days it currently takes in some markets.

3. Direct Market Access: By leveraging blockchain technology, investors no longer need to go via intermediaries such as banks or brokers. This can help reduce trading fees, which all else equal, can boost liquidity on platforms. Moreover, with smart contracts and programmed automation in place, it paves the way to the potential for 24/7 access and trading.

4. Automated KYC/ AML: Another key advantage of using digital asset exchanges which have their technology infrastructure built on the blockchain is that KYC and AML can be significantly faster and streamlined. By storing investor information on the blockchain, it can be accessed at any time instead of having to request investors to fill up forms every time they wish to access a new type of product. Using this customer information on target returns and risk profiles, digital exchanges can then set algorithms to intelligently recommend relevant investments and other products.

To learn more about private investment opportunities, visit ADDX, one of the world’s first fully regulated digital exchanges.

ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require millions or more to enter. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.

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