Speak to any private markets participant and the issue of liquidity will always come up. Individual investors may need to access their investment capital on a more regular basis than institutional investors and, for all the progress made, may not be as comfortable with the notion of their capital being tied up in a fund structure for a minimum of 10 years. 

In 2020, the US Department of Labor made it easier for defined contribution pension plans to invest in private equity, noting that pensions choose products that have a “liquidity component to manage the participant-directed deposits and withdrawals from the fund”.

According to Jan Philipp Schmitz, head of Ardian Germany and Asia, secondaries are well suited as a product for private wealth clients to invest in. 

“It’s not a blind pool – you know what you’re buying into, [there’s] quick cashback, no J-curve, [and it’s] well diversified,” he says, adding that Ardian’s secondaries funds mainly invest in Western markets, blue-chip GPs and good assets that the firm knows through its database coverage. 

“It’s really a pretty well-suited, ideal product for the private wealth market,” he says.

Utilising technology

One mechanism that could facilitate liquidity in private equity funds is the concept of tokenisation – the process of converting assets, such as a stake in a private equity fund, into a tradeable digital security. KKR, Partners Group and Hamilton Lane all tokenised portions of their funds last year.

“Technology is disrupting the financial market, so in my opinion there is potential that this will grow, but there also might be some issues or obstacles,” says Petr Poldauf, investment director at Schroders Capital, who focuses on secondaries within private markets. 

“It’s still not proven, so it has to be tested, security-wise, and [that] everything works well. Generally, I think we can’t avoid [the] technology disruption trend.”

If efforts by the various tokenisation platforms that have launched in recent years come to fruition – US-based Securitize and Singapore’s ADDX are two firms that have made headway over the last 12-18 months – that endpoint could come sooner than expected.

There are multiple issues that need to be addressed before tokenisation can deliver liquidity en masse to individual LPs. In the tokenised portion of KKR’s $4 billion Health Care Strategic Growth Fund II, for example – which partnered with Securitize in September – secondaries trades can only be done between investors that are matched via Securitize’s system and carried out at the feeder fund level, not at the main fund level.

There’s also the problem of not tripping US publicly traded partnership tax regulations, which require that no more than 2 percent of underlying interests in a limited partnership are traded within a given year, or else the fund is taxed as a corporation. As Carlos Domingo, Securitize’s founder and chief executive, tells us (see p. 53), one of the “beauties” of tokenisation is that measures can be put in place to avoid tripping PTP rules.

A world in which millions of individual investors are selling LP stakes in private equity funds may be closer than most people think. At an industry conference in Cannes last year, a senior executive at a European family office mentioned to Private Equity International that his team was interested in the tokenisation aspect of private equity funds due to the liquidity mechanism it provides. As private equity comes downmarket to individual investors, tokenisation could prove a useful way to facilitate liquidity and allow for greater retail participation in a traditionally illiquid asset class.