Navigating a Virtual Asset Landscape

Elliot Refson: We are seeing a significant desire from family offices and high-net-worth individuals (HNWIs) to increase allocations to alternatives. Equally, many alternative managers are keen to diversify their investor bases away from a traditional reliance on institutional investors because that capital has been drying up.

To illustrate this with some numbers, the Bain Global Private Equity Report noted that family offices and HNWIs represent around 50 percent of the US$295 trillion global AUM. However, those same investors represent just 16 percent of AUM held by alternative managers. What that ultimately means is that private wealth represents a US$150 trillion opportunity for alternative managers. Around US$24 trillion of that is already allocated, which leaves a further US$126 trillion on the table.

Philip Pirecki: There is a massive opportunity here to use technology, including tokenisation, to cut through some of the legacy challenges that have prevented these investors from accessing alternatives, thereby broadening managers’ distribution potential. There is absolutely no doubt that this is the direction of travel for this industry, as is evidenced through our own research, such as our recent Trends in Alternative Investing report.

ER: Over the past five years, we have seen a 50 percent decline in the number of collective funds, both in Jersey and across other jurisdictions. However, that decline has been more than offset by a significant increase in funds of one, smaller co-mingled funds and managed accounts, including those structured in corporate vehicles. This trend can clearly be illustrated by the record number of limited partnerships that have been created in Jersey in recent years.

The reason for this is that HNWIs and family offices want to retain control over their capital and investments. They want to access alternatives because of the enhanced returns and diversification on offer, but that demand is selective. They don’t want to go into collective funds that distribute their money far and wide, they want to be able to be highly targeted in their approach and they are structuring accordingly.

PP: I see this as a natural progression. If you have the technology and capabilities in-house to retain control of your assets, why would you want to go into a pooled vehicle? I recently attended a legal conference where it was said that, for the year to date, just over 70% of capital within the hedge fund space had gone into separately managed accounts, rather than pooled vehicles, which gives you a sense of the scale of the shift.

ER: We are seeing an increased appetite for private credit, driven by investor demand for yield. Overall, though, I would say that we see the most promising opportunities in asset-based finance, infrastructure and the sustainable sector.

PP: I agree with all that, and would add that we continue to see secondaries leading much of the structuring work.

ER: What is most important from a jurisdiction perspective is to stay relevant and to evolve with the needs of both managers and investors. Without that, financial centres will simply die out. History is littered with examples, the classic one being hedge funds in Bermuda, which moved to Cayman, pretty much overnight.

Staying relevant means providing the structures that managers and investors are demanding, in terms of funds of one, small co-mingled funds and managed accounts. It also means embracing the virtual asset landscape, or the tokenisation of real-world assets, which is proving crucial to creating efficiencies and therefore bridging the divide between private markets, family offices and HNWIs.

For this to happen, jurisdictions need to balance the fostering of innovation with the protection of investors, by way of a robust regulatory framework. Jersey treats virtual assets just like any other asset class. This approach led to Jersey regulating the world’s first bitcoin fund in 2014; becoming one of the first jurisdictions globally to introduce a policy applying an anti-money laundering and CFT control framework for virtual asset exchanges in 2016; and publishing guidance on initial coin offerings in 2018. In August last year, meanwhile, the Jersey Financial Services Commission issued further guidance on asset tokenisation and ICOs, designed to support this new business, all of which is to say, we have a regulatory framework in place.

This regulatory framework exists, of course, within the wider context of Jersey as a jurisdiction with our base case of tax neutrality, and political and fiscal stability. Furthermore, Jersey has a pragmatic approach from a regulatory and legal perspective, underpinned by world class infrastructure, including the second fastest broadband speed in the world, and more than 14,000 experienced industry professionals ready to support the evolution of managers as they navigate this new world of tokenisation and blockchain.

When virtual currencies first emerged a decade ago, there was a huge amount of scepticism. Ten years on, this is now a US$3.8 trillion industry. Applying that same technology to alternative assets will dramatically increase efficiency, opening up these funds to a whole new pool of investors. On that basis, we see this market exploding over the next few years.

PP: What matters is not only whether a jurisdiction is capable of handling institutional level industry today, but also whether it is going to continue to be capable in five years’ time. I would argue that this narrows the possibilities down considerably and, if you don’t keep up with what is required, you can find yourself out of the game very quickly.

In terms of what those capabilities look like, I would point to an industry that is engaged at a jurisdictional level; a regulator that understands that they are providing an export service – selling stability, rule of law and continuity – and a commercial government that is willing and able to think proactively and solve problems where they arise. As Elliot mentioned, Jersey has the second fastest broadband in the world. Equally importantly though, it also has five undersea cables. That is redundancy in depth and it only exists because, two decades ago, the Jersey government recognised that a 21st century jurisdiction would need to have fibre to every dwelling on the Island and it prioritised accordingly.

Finally, I would say that scale and capacity matter. The capability of a jurisdiction today to manage the scale, complexity and volume of business, not only at an institutional level, but for the largest family offices and ultra-high-net-worth individuals, is a huge differentiator. It really starts narrowing down the available options when it comes to jurisdictions of choice.

This article was first published in Buyouts.

Learn more about the authors: Elliot Refson and Philip Pirecki.

For more insights, read our report Trends in Alternative Investing, produced in partnership with IFI Global.