An Alternative Approach

Elliot Refson, head of funds at Jersey Finance, sits down with Asset Servicing Times to discuss the company’s recent white paper, and trends in alternative investment.

The white paper identifies three simultaneous diversifications occurring in alternatives: investor, structural, and product. Could you please explain these key trends and what is driving this transformation across the industry?

The key trends that the white paper identifies break down into three clear buckets, investor, structural, and product:

The white paper identified that from an investor perspective there is a desire by family offices and high net worth (HNW) investors to increase their allocations to alternatives. The other side of this coin is the need for many alternative managers to diversify their investor base away from their traditional reliance on large institutional investors for their funds which has been drying up.

From a structural perspective the white paper identified that there is a shift away from traditional pooled funds to funds of one, managed accounts and co-investment vehicles to accommodate investor demand and this structure diversification is likely to get a further boost from new technology.

And from a product perspective the white paper identified that there is a trend to a growing use of AI and the rise of digital investing, including tokenisation. Tokenisation offers one potential solution to the transparency, liquidity and cost problems which have held family offices and high net worth investors back from allocating to alternatives.

Your Jersey data shows impressive growth primarily coming from non-traditional structures rather than standard collective investment funds. What does this shift indicate about the industry’s direction and investor preferences?

What we have seen over the past five years is a 50 per cent decline in the number of Collective Investment Funds both in Jersey and across jurisdictions.

This decline has been more than compensated for by a significant increase in the assets under management (AUM) and number of funds of one and smaller co-mingled funds that are structured in corporate vehicles. This is highlighted by record number of limited partnerships created in Jersey over recent years.

There are two reasons for this: the first is that high net worth and family office investors want more control of their capital and investments. The second is that while this group wants access to alternative investments for their enhanced returns and diversification this demand is selective hence specific structuring rather than investing in diversified funds.

The research indicates managers are shifting from institutional to family office and HNW investors, yet only 5 per cent of HNW investors currently allocate to alternatives despite 53 per cent planning increases. What opportunities are behind this significant shift, and how substantial could this market become?

I think that one of the drivers of managers looking to high net worth and family office investors is that institutional funds are running dry, but it would appear that they are pushing on an open door. Let me put this new opportunity for managers to raise capital in perspective. The Bain Global Private Equity Report notes that individual investors hold roughly 50 per cent of the estimated US$295 trillion of global AUM but those same investors represent just 16 per cent of AUM held by alternative investment managers. In general terms that boils down to a US$150 trillion opportunity, of which just US$24 trillion is allocated, leaving US$126 trillion on the table.

Managed accounts usage among advisers has tripled from 18 to 56 per cent according to your research. What factors are driving this dramatic adoption, and how do you foresee this trend evolving as it extends into retail markets?

I think that we broadly touched on this earlier. There are two reasons for this: the first is that high net worth and family office investors want more control of their capital and investments. And the second is that while this group want access to alternative investments for their enhanced returns and diversification this demand is selective, almost case be case if you like, hence specific structuring rather than investing in diversified funds.
More widely however, as we have started to see with tokenisation Investment structure diversification is likely to get a further boost from new technology.

Your findings indicate managers are now offering multiple vehicle types — managed accounts, co-investments, funds of one, and hybrid structures. How is this proliferation of options altering the investment landscape, and what advantages does it bring?

I do not think that any of these structures are new to the investment world, but they are certainly being applied more to the alternatives space. The clear advantages are that the investors keep control of their own assets and can be more specific about the investments they want. As to how it is affecting the investment landscape in this new world this is simply what a manager needs to do to raise funds from the new investor base and of course as investors are more selective about the investments that they make the manager must be more aware of how he structures each deal.

The white paper cites McKinsey projections of US$2 trillion in tokenised assets by 2030, with ambitious investor allocation targets. How feasible are these projections, and what steps are needed for tokenisation to transition from pilot programmes to widespread adoption?

There are a number of surveys out there which indicate various levels of take up for tokenisation — some larger, some smaller. In a 2023 report by Northern Trust and HSBC, 5 to 10 per cent of all assets are estimated to be digital by 2030 — which suggests a number circa 15 to 30 trillion.

But what is needed for tokenisation to transition to the mainstream is standardisation. Each deal currently is being done from scratch, many are complex and expensive, but standards will emerge, just as they did for investment funds, private equity funds and hedge funds and at every other iteration of markets.

That aside, distribution is also key. We see institutions tokenise assets for their own clients where they effectively manage the book which works but is ring-fenced, and we are seeing platforms emerge where distribution is more difficult, but winners will emerge, and the platform model will likely become mainstream.

All of this provides massive opportunities across the board and as we have seen historically many of tomorrow’s solutions are copied and pasted from history. And I think that this will broadly be the case, for example with placement agents moving into marketing tokenised offerings. For this reason, I do believe that once the market has filled these gaps widespread adoption will follow quickly.

But let us not forget that the tokenisation of real-world assets grew out of the virtual assets sector. Virtual assets such as bitcoin, emerged over a decade ago as a revolutionary concept but are now almost mainstream with a value touching US$4 trillion. This sets the precedent and the trajectory of the pick up in demand for the tokenisation of real-world assets which have the added attraction of already being accepted investments.

Your research notes that 60 per cent of firms currently use AI in data-related distribution, coinciding with blockchain adoption. How do you envision these technologies collaborating to address conventional challenges related to accessibility, transparency, and efficiency?

The digitalisation of real-world assets refers to the process of converting tangible and intangible assets into digital tokens that can be managed, traded, and stored on a blockchain.
Accessibility, transparency, and efficiency are a by-product of this process, as are cost savings, decentralised ownership, diversification opportunities, and a streamlined administrative process. Enhanced liquidity is also a possibility.

Private credit has exceeded US$2 trillion and is expanding beyond direct lending into asset-based financing. McKinsey describes this as a “generational opportunity” — could you elaborate on the factors driving this growth and where the most promising opportunities lie?

What is driving the massive growth in private credit stems from regulatory-driven bank retrenchment, strong investor demand for yield, private equity growth, and the asset class’ ability to innovate into asset-based financing and other nontraditional areas. The most promising opportunities lie in asset-backed finance, infrastructure and the sustainable sector.

Your research identifies sustainable sectors as the largest growth opportunity, with 35 per cent of institutions emphasising this area, yet you observe a lack of adequate measurement tools in the industry. What dynamics in sustainable allocations are not fully captured by the market?

The research shows that allocations from pension funds, sovereign wealth funds and family offices are growing very strongly but the reason that this is under the radar is that the industry has not yet got the right tools to measure what is going on.

For example, sustainable investing is still often wrapped up with ESG. Some of it is in that area, but much of it is in the private market domain. Equally, much of the investment that is going into the renewable energy sector — a large part of the sustainable investing — is being counted in the infrastructure category. Also, what impact funds are investing in can be difficult to determine.

To examine what is really going on, the research went to the source of all these sustainable allocations: the investors, through a survey of 252 pension funds, 50 sovereign wealth funds and 50 large family offices. All of those surveyed increased their allocations to the main sustainable finance sectors in 2024, some substantially so.

Renewables is easily the most popular sector. But biodiversity/nature grew the most rapidly last year. It was followed by waste/recycling water and then forestry/timber.
Our own research reflects the 2024 Natixis Private Assets Report, which surveyed 500 institutions worldwide, found that the sustainable sector is now the biggest opportunity in private markets.

It is likely that as the sustainable sectors grow each will become a recognised private investment category in its own right. The renewable sector is often already categorised this way. Biodiversity/nature will likely become so too. Other sustainable sectors could well also follow.

Jersey has positioned itself at the forefront of these trends with innovative regulatory frameworks and diverse vehicle options. How do you perceive Jersey’s role in facilitating this industry transformation, particularly concerning digital assets and tokenisation?

From a jurisdictional perspective the challenge always is that financial centres must stay relevant. Those which do not evolve to serve the needs of the managers and investors who use them and who do not reflect the advancements in their markets simply die out. History is littered with examples of this.

As the virtual asset landscape evolves, the need for robust regulatory frameworks is crucial. Jurisdictions need to find a balance between fostering innovation and protecting investors.
One key factor that sets Jersey apart from other jurisdictions is the almost unique and collaborative approach taken by our industry: Our service providers, our government and our regulator, the Jersey Financial Services Commission, which has many years led to highly successful innovation.

From the starting point, back in the day, that Jersey would treat virtual assets as it would any other asset class it was exactly this approach which led to Jersey regulating the world’s first bitcoin fund in 2014, which led to Jersey being the first jurisdiction to apply an anti-money laundering (AML) control framework for virtual currency exchanges in 2016 and ICO guidance in 2018. It is this guidance which was the facilitator of the developments that have taken place in Jersey.

More recently our regulator issued two further guidance documents, the ‘Tokenisation of Real-World Assets (RWA)’ and ‘Initial Coin/Token Offering (IC/TO)’ the latter being an update of the original ICO guidance from 2018. Both documents are aimed at supporting this new business in Jersey.

With this framework in place let me touch on the wider advantages Jersey brings to the table as a jurisdiction for the tokenisation of real-world assets.

In Jersey our base case is tax neutrality and stability; both political stability and fiscal stability as well as a minimal change outlook from a regulatory, legal or economic perspective underpinned by world-class infrastructure — for example the fastest broadband in the world — and by the broad and deep expertise of the 14,000 people who work in our industry.
And it is against this backdrop that we will continue to iterate to support evolution of managers and the industry.

 

Service provider implications

Considering these trends from a service provider perspective, what are the principal operational and technological challenges that fund administrators and custodians should prepare for?

Obviously, we are not a service provider, but I think that what we are seeing here is the natural evolution of markets. From a structuring perspective there is nothing new. Funds of one, co-invest and managed accounts have been around for a long time.

Tokenisation is also a natural evolution of investments which began with the introduction of railroads and industrialisation in the 1800, from this we saw the beginning of large-scale investments which led to stock exchanges to facilitate share trading. The first mutual fund or unit trust came in 1924, then came the modern portfolio theory in 1952 to name just a few milestones. More recently we have seen the rise of ETFs and passive investing.

The next step of this evolution is the conversion of assets into digital tokens that can be managed, traded, and stored on a blockchain bringing with it all the benefits we spoke about earlier. Initially it’s fair to assume that there will be a hybrid model but ultimately it will be blockchain exclusively.

Your conclusion suggests that these multiple trends will create unprecedented opportunities. For the broader ecosystem, including service providers, what capabilities and investments should they prioritise to support this evolving landscape?

There are a number of players creating supporting companies for each step of the services required in this new world. Tokenisation platforms and online placement agents for tokenised offerings are a case in point. We are seeing some of the service providers acquire these firms to offer end to end servicing. But of course, parts of the process can be outsourced. It is up to each of the service providers to determine the part that they will play in the next step of the evolution of investing.

This article was originally published on Asset Servicing Times.