Why Better Data Leads to Better Pricing

Private markets have a liquidity problem. The existing mechanisms of liquidity price assets with significant intervals, which leads to poor data and compounds the lack of liquidity — this, in turn, leads to mispriced assets.?

The key to fixing this is fixing the poor data. Better liquidity in the private markets results from making trusted and validated data available to market participants.

To see the future of private markets we first need to look at public markets. For the most part, public markets are highly liquid marketplaces for financial assets. Publicly traded assets such as stocks, bonds, and currencies change hands billions of times throughout a normal day. On top of these spot markets, we have well-formed global derivatives markets, including futures and options, that trade based upon the value of the underlying assets. Investor capital has historically flooded public markets because of the liquidity available for these financial products. The sheer volume of investors expressing their opinions about these assets via their bids and asks at any given time makes it such that market participants can move in and out of positions with relative ease. As market conditions change, investors can easily pivot, hedge, and move their capital around. For these reasons, investors prefer liquid assets and price them as such.?

But these well-formed, highly liquid public markets didn’t come about by accident. Trusted data is the essential base layer that allows these markets to function. Trusted data removes the asymmetry of information in markets. It allows everyone to converge on that which is true about the state of an asset. The standards and regulations that govern trusted data in public markets are largely set by the Securities and Exchange Commission (SEC) in the U.S. and ESMA in Europe.?

Publicly traded companies face stringent rules and regulations around the disclosure of material information relating to their business. In addition to filing quarterly and annual reports with the SEC, public companies must implement internal accounting controls and hire independent third-party auditors to review and sign off on their financial statements. The public uses this information to draw conclusions about the health of these businesses and express their opinions through various trading strategies. Their opinions about these assets rely on trusted data. Without the data, there would be too much information asymmetry in the market. This would prevent investors from properly deploying capital and managing risk. Liquidity would diminish. Price dislocation would be prevalent.?

Private Markets

Because private markets lack this well-formed infrastructure around trusted data, price dislocations occur at a much higher rate than in public markets. Private markets do not have a single oracle for trusted data, such as the SEC’s EDGAR database in public markets. This results in information asymmetry within the market.?

Via SEI whitepaper “Private Market Liquidity: Illogical or Inspired?”

For an example of how this leads to poor pricing, we will look at the commercial real estate market for light industrial warehouse space. ?Amazon was able to issue $3.25 billion of 30-year bonds last year at 80 basis points over the 10-year treasury rate in the public markets. This offering was 3x oversubscribed by investors. Meanwhile, a triple net lease with Amazon’s credit backing the property trades at a 20% discount in private markets. Never mind the fact that the investor gets the building along with Amazon’s cash flows. This is the same credit and the same cash flow trading at a premium in one market and a discount in another market due to broken data.?

So, naturally, the question becomes, “How can we create a system through which market participants can observe trusted data to converge on price discovery of private market assets?”

We are not the only ones thinking about how to tackle this issue, albeit in very different ways. In mid-January, the London Stock Exchange Group (LSEG) proposed creating a market for private company shares that trade publicly on the venue during limited trading hours — essentially a hybrid public/private model with fewer regulatory hurdles than going public and limited trading windows.?

However, the LSEG’s plans are a half-measure without good data. While it presumably would add to the liquidity profile of a private company, the proposed venue would not solve the trusted data problem and would only apply to companies, not all private market assets — which makes it merely a band-aid solution for the root, underlying issue.

But Distributed Ledger Technology can change the game around data, data integrity, real-time data access, and data sovereignty.?

Enter Blockchain Technology

Blockchains, at their most primitive level, are simply decentralized ledgers where everyone agrees on balances. These ledgers can be used to commute trust in the state of data and help establish the veracity of the performance of an asset. Today these ledgers are managed by banks and other centralized entities, with rating agencies providing surveillance on only the largest of asset pools. The centralized repositories record the debits, credits, and all other information. With this technology, asset owners can control their own data and the data credentialing can occur in an automated fashion; data is embedded into the payload of a block with no intermediary.

So how can this improve price discovery in private markets?

With this new technology, and in conjunction with existing and improving technologies such as AI, we can now automate the data capture of all the necessary information needed to price an asset without the goal of building giant data lakes. Let’s walk through an example using commercial real estate (CRE).?

The process through which we price a commercial building today involves asset managers, accountants, property managers, and third-party appraisers gathering all of the relevant data to perform a discounted cash flow analysis with a comparison to recent sales of like assets in like markets. Depending on the complexity of the assets and the size of the portfolio, this process can take several months to complete. And, if an owner decides to sell a building, the marketing and due diligence process can take anywhere from 3-6 months.?

A lot can happen in 3-6 months.?

But what if we could automate this process? What if we could automate the data collection process and allow third-party appraisers to mark these assets to fair value in a continuous process as market conditions evolve? And what if all this data was anchored to a blockchain, allowing for permissioned access amongst market participants to the original data sources so the condition of a data lake would never be a concern??In addition, if this data were altered, we would know because the change of state of that data would not be logged into the payload of a block.?

This is happening today with some of the largest asset managers in the world. Inveniam sits at the base layer of this new ecosystem and tech stack for private market assets. We activate high-functioning data that facilitates better valuation, price discovery, and secondary trading.?

As this emerging ecosystem evolves, the asset owners and managers that have strong data will have an advantage in the marketplace over their competitors. Investors will be able to price their assets with relative ease compared to an asset that is using traditional means and/or unreliable data. Why would anyone wait 3-6 months for valuation on a property when they have all of the deal room data fully up to date right in front of them on another asset using this new technology? Asset owners and managers should be asking themselves how poor data could impact the value of their assets this decade.?

Furthermore, asset owners and managers should understand that immutably recording the data on a blockchain allows for increased optionality in managing a portfolio. For example, a commercial real estate owner may have an opportunity to expand or reposition its portfolio for a new, exciting strategy. To capitalize on this new opportunity, traditionally, the owner would need to either seek new financing through traditional banking means or sell off existing assets to finance the new opportunity. This is complicated and time-consuming.

In the new world, owners that have their pricing data anchored to blockchains will be able to move this data onto a tokenization platform where they can create digital assets that represent an equity interest in their property. Trusted data underpins these digital assets and gives them integrity for price discovery. And due to the programmability of smart contracts connected to blockchains, these owners will be able to automate investor onboarding, capital calls, distributions, and capital table management, with clarity of data ingested into the smart contract.?

The output here is that investors can establish price discovery, and this drives better accounting treatment, better lending, and eventually even more liquid positions for private market assets via secondary trading. Owners can access liquidity in the market that was previously unavailable due to poor data. Now the owner can finance a new project without selling off 100% of other high-performing assets in the portfolio.?

As we noted in the first issue of "The Missing Link,” investors have been increasingly flooding into private market assets over the last 10 years. Due to macroeconomic forces, we can anticipate this trend further accelerating this decade. Investors in these markets will demand liquidity.

The end state of the journey is better pricing and the global trading of liquid private market assets in secondary markets.?

Inveniam, along with our ecosystem partners, is bringing this reality to the market. We’re hosting an event in Miami in March covering the future of private markets — we hope to see you there.?You can also keep abreast of our journey by following us on social media and by subscribing to “The Missing Link.”?

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