Potential for crypto wallets to redefine investment portfolios

New research from Franklin Templeton’s Industry Advisory Services division has identified the role cryptographically protected wallets could play in enhancing the ‘interoperability’ between different types of investments held in a single portfolio.

The research suggested that leveraging a wholly ‘wallet-based’ portfolio would eliminate several layers of administrative complexity and incompatibility among diverse investment management systems, instead providing a single and consolidated method of tracking investments and completing brokerage functions.

The research and analytics and Industry Advisory Services teams from Franklin Templeton said in the commentary that the wallets allow assets to be stored “alongside all other holdings”, which at current include digital and tokenised assets such as cryptocurrency, fungible tokens “that represent participation interests in various protocols and decentralised apps” and non-fungible tokens (NFTs).

“The design of the financial market infrastructure has forced each organization to maintain multiple sets of accounts for each investor serviced. Each firm processes individual transactions on a bilateral basis, moving payments and securities between distinct client accounts,” the research said.

“Clients owning the same stock at two different brokerage houses would see two distinct listings and could not aggregate their exposure. Fund ownership requires two ledgers: the ledger recording the fund’s holdings of securities, and the shareholder ledger that shows how much of the fund’s interests each shareholder owns. This makes it impossible to commingle fund assets.

“Even if an investor were to own two equity mutual funds with the exact same strategy and investment universe, their ownership would be recorded on two separate shareholder ledgers and each fund’s holdings would be administered in separate brokerage accounts.

“Owning an exchange-traded fund (ETF) eliminates one set of bookkeeping. Investor interests in these offerings are recorded only on a shareholder ledger until a shareholder redeems their ETF “in-kind” in the primary market. The growing use of separately managed accounts (SMAs) represents the opposite approach.

“Whereas with an ETF the holding is only of a fund (with no individual security holdings), SMA account owners only hold securities and there is no fund structure, and thus no shareholder ledger to administer.

“Private funds add further complexity and even more accounts. Most of these offerings are recorded via a roster of limited partnership (LP) interests maintained bilaterally with each distribution partner. An investor may choose to increase their LP interests in a fund over
time, but if the second allocation were done via a different bank or advisory firm, the fund would need to maintain and administer two LP records for the investor—one with each organization.

“Co-investments create yet another set of accounts between each alternatives manager and investor that sits on the side of the fund’s investment in that asset.”

The research suggested the possibility for other physical and digital assets to mirror the NFT-based token approach to investment holdings, allowing investors to capitalise on the true benefits of portfolio diversification all in one place.

“All these tokenised assets—cryptocurrencies, NFTs, tokenised securities, tokenised funds, tokenised physical assets and new forms of digital “money” —can coexist within the same cryptographically protected wallet,” the research said.

“One can see how this defragmentation of the portfolio and consolidation of its holdings in a wallet could reduce the frictions involved in changing adviser and increase the portability of an individual’s portfolio, e.g., to another adviser. This will intensify competition to add value to the client in new and additional ways to retain clients and/or attract new ones.”

“From an investor perspective, beyond the obvious benefit of exchanging payments and assets in real-time, several other aspects of a portfolio’s operations will likely be enhanced by traditional financial assets existing in tokenised form and held in a cryptographically protected wallet.”

These benefits include:

• Proportional yield: Today, many funds pay a yield, which is typically calculated and paid out to shareholders of record at the start of the trading session. Subsequent activity during the trading day is not factored into the calculation. With blockchain-based, tokenized funds, each NAV cycle can be broken down into minutes or even seconds. Every movement of fund shares during that window can be assessed as a unique payment.
• Fractional bond and mutual fund shares: Today, the ability to invest small amounts of money into individual stocks or ETFs allows investors to participate in the market without needing to purchase a full share. However, fractionalisation is not yet available in bonds, mutual funds and many other offerings. Tokenised instruments on blockchain remove that barrier, allowing fractionalization and administration of any financial instrument down to tiny increments.
• Continuous net asset value (NAV): With tokenised fund shares and blockchain-based transactions, the exact holdings of the fund and its value can be calculated at any time. Similarly, the number of outstanding tokens and the owners of those tokens can be readily monitored. As a result, the industry would be able to move to NAV-pricing on demand.