You don’t need us to tell you that individual investors are ready and willing to take the leap into private markets (but if you do, you should probably check out this article before reading this article). Private equity for its part is eyeing up individuals as the next growth engine for a sector where they account for just 16% of assets under management despite holding 50% of global wealth. 

Of course, it’s not as easy as simply opening up private markets to private wealth. Stumbling blocks around regulation and infrastructure have made pairing up individuals with alternatives tricky. Wealth managers run a largely customised model for qualified investors that can’t practically scale in their current format to include large numbers of smaller investors. And, while developments in technologies like tokenization now present the chance to credibly address that, regulation has struggled to innovate as quickly as the tech. 

But it’s a significant opportunity, and many alternative investment models have emerged over the last two decades aiming to open up private markets to the masses – some more successfully than others. 

Lessons from the past

The turning point for alternative investment came in 2008. The Global Financial Crash robbed individuals of their faith in established institutions and prompted an explosion of disruptors seeking to cut out the middleman, offering investment opportunities such as peer-to-peer (P2P) lending, crowdfunding and property finance directly to the public. 

It wasn’t an entirely new sector, there were a couple of early players in both the UK and US in 2005 specialising in peer-to-peer lending. But 2008 supercharged alternative investment.  Incumbents faced a reputational crisis as well as financial challenges that seriously hindered the credit supply. Suddenly, reputable borrowers – particularly small and medium sized businesses – were struggling to get loans, just as investors were looking for alternative investment opportunities. 

A host of businesses rose to service this need, Funding Circle launched in 2010 in the UK to funnel institutional money into SME loans. CrowdCube followed the year after, giving self-certified sophisticated investors the opportunity to buy equity in startups. 

As the sector matured other opportunities emerged. Cogress, founded in 2014, and CapitalRise, founded in 2015, gave self-certified high net worth and sophisticated investors the opportunity to finance prime London property developments through joint venture agreements (JVA). 

Noticing a theme? While the demand was there, infrastructure had yet to catch up. The fledgling sector lacked the processes and technologies to truly scale, and opportunities remained limited to wealthy investors happy to engage with complicated structures like JVAs.   

Crowdfunding was one of the first models open to everyone – just not as an investment vehicle. Kickstarter launched in 2009 offering anyone the opportunity to back a creative project in exchange for rewards. The projects listed on the site ranged from novelty card games to fully fledged startups, with creators inviting members of the community to back their idea in exchange for rewards, as opposed to investing.

In short, while the early innovations succeeded in opening up private asset classes to a broader range of investors, they were limited by regulation and infrastructure to qualified, motivated individuals. This was a small group happy to put up with the niggles of minimum viable products (MVPs) that included high risk borrowers, admin heavy structures, limited information and a lack of liquidity, all for the opportunity to diversify their portfolios into private markets.

The problem with scale

Today, retail demand for private assets is on the rise, aided by the popularity of models like crowdfunding, downturns in public markets and a growing desire to hedge against inflation. Regulation has made strides to meet this demand; European Long-term Investment Funds and the UK’s Long-term Asset Fund both offer individuals the ability to invest in funds with shares in private companies and infrastructure projects. 

These have prompted a shift in the wider industry. Asset managers are pivoting away from the off-the-shelf products they’re known for in favour of funds that cater to the growing demand from smaller investors; a practice not without its own challenges.  

But private markets lack the digital infrastructure of public markets. The sector spent decades serving a small number of large investors through manual processes and now lacks the ability to collateralise, register and report to a large number of small investors. Distribution models need to evolve. 

What’s next? 

While crowdfunding has succeeded in distributing private market opportunities to individuals, we’re still a way off being able to offer every investor – regardless of size – unfettered access to private markets. Real scale will only come with the mass inclusion of investment firms and wealth managers. And these providers need infrastructure that can not only streamline admin-heavy operations like capital calls, registration and reporting, but that also provides a frontend where investors can onboard quickly and easily. 

The ability to integrate with other platforms and products to increase awareness among new audiences is another key factor for success long-term. For many investment providers used to cultivating lasting relationships with a few large investors, the need to appeal to and earn loyalty from tens of thousands of small investors is a real gear shift. 

It is developing blockchain technologies that will provide the answer to the issue of scale. Tokenizing private assets – i.e., leveraging blockchain technology to create a digital record of a real world asset  – digitalises the whole investment processes, enables faster settlement, automates operations and reporting, and increases transparency and security. 

The leap from relatively little digital infrastructure to blockchain is sizable, and not one the industry will make in just a few years – it’s taken us fifteen to get to this point. A modular, integrated approach to developing digital infrastructure that provides flexibility around integration, distribution and administration is the only realistic path for widespread adoption. This transition – moving the sector towards a truly scalable digital solution that really opens up the private markets to individuals – is what Hedgehog is all about. Contact us to discover how our solutions can help your firm deliver a future-proof, competitive experience for individual investors now and in the future.   

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