UNLOCKING THE POTENTIAL OF PERSONAL CAPITAL IS GOOD - FOR ALL
Fractionalization for Consumers
Agricultural land. Hui (Chinese: informal loan clubs). Microloans in Bangladesh. Timeshares and property. Luxury goods like airplanes, yachts and art. Single cigarettes and many more.
These are a few examples – from antiquity to today’s emerging factional stock investing – of
how typically expensive goods and services can be divided up, or fractionalized, to allow individuals to acquire and benefit from them. Typically out of the financial reach of many, these opportunities have, with fractionalization, been made accessible for more. And opportunities to invest, and benefit, from fractionalization are now available to more people, but not yet all and not yet for everything.
This is the start, and a promising one when creatively considering the vast opportunity, of a longer transformation to release the financial potential of people. Fractionalization gives access to potential future wealth sooner and instead of debt that, sadly and all too often, can last entire lives – or longer.
In this article, we discuss how fractionalization – the act of fragmenting expensive assets into accessibly priced portions – can benefit consumers. We will explore examples from the past to present, and how some preliminary steps have provided select consumers with access to more, but has yet to empower them to unleash their wealth and power through fractionalization. Unfortunately, we will also see how forms of fractionalization have been detrimental. Lastly, we will consider what fractionalization could become with greater vision. The destination is far, but much progress will be made along the way for the betterment of consumers worldwide.
In the end, we will show how fractionalization empowers consumers through fullness (amalgamating and empowering the full value of individuals’ assets) and fluidity (of assets, access and activity). Whether enjoying a ski lodge (via a timeshare), enabling tokenized investing (e.g. digital currency for stock and other funds), buying into luxury investments (e.g. shares in a barrel of whiskey or valuable art) or, ultimately, building full-picture portfolios with real-time asset release to repay debts and build wealth (e.g. releasing home value to invest while paying off the mortgage), true fractionalization can unite and unleash financial wealth to benefit to individuals and society – today and into the future.
Fractionalization: the past and today
Fractionalization has existed – and for some time. It is commonly associated with splitting the price, and ownership, of a major purchase into smaller ‘shares’. This allows individuals – as part of a known or unknown group – to acquire and benefit from the asset. The simplest
example is how companies offer shares to individuals for a fraction of their total value – to then deliver a fraction of their profits in return. More recently, crowdfunding has shown how individuals can support and gain from an opportunity by enabling the recipient of said funds to enact their idea and then, it is hoped, succeed enough to return funds to supporters. These activities help the recipient of the funds overcome a problem, while offering supporters access to opportunity typically outside their financial capacities (i.e. launching or buying a business outright). Each is a broad example of fractionalization: the process by which expensive opportunities are made available, in chunks, to individuals for the potential future benefit.
This isn’t fractionalization in its truest and best form, however. Splitting an asset price into purchasable segments enables access, but merely expands the definition of ‘investor’: from wealthy buyers to a more modest investors who, individually or in groups, fund for future returns. And the emphasis here is on smaller investments and returns.
Let’s consider a modern example: buying into a Gulfstream G550 private jet (approx. US$60M in 2018). Once exclusively for the very rich, individuals can now purchase right-of-use for a private plane. But ownership and use are different. Whether a jet or a ski lodge, this definition of fractionalization provides access to the jet, but not ownership.
This is not ideal fractionalization for several reasons.
This is membership – not ownership. Investors gain access and have limited liability (e.g. sharing the cost of maintenance), but they don’t own the plane (even if some might think so).
Investors must indirectly pool funds for this ‘membership’, but such groups bring challenges, and complications, particularly from additional costs or other issues.
The value of the fractional ownership is fixed in two ways. Like the The Eagle's 'Hotel California', an investor can sell out almost any time, but may not gain added value. More broadly, the value of shared access is fixed within the investment. Individuals cannot use a shared membership in a Gulf Stream G550 or a Méribel ski lodge as collateral to fund other investments like buying a second home, investing in a business or otherwise. The funds are locked in and to the jet. Here is the clearest indication that this is not fractionalization, which should empower individuals with enhanced access, wider ownership, greater flexibility and freer transfer value of assets into other areas of wealth accumulation.
Each example provides better, initial access, but not support for financial independence to move – one block at a time – and grow capital. Instead, the limits of this form of fractionalization employ artificial constraints, rules and siloes that benefit the sellers while failing to empower individual consumers to greater things.
Single cigarettes (loosies) or slices of art sans guarantee
The examples above show how, for some, fractionalization offers access to previously inaccessible assets, but with minimal flexibility and fluidity. Sadly, fractionalization has also been used to unlock the profit potential of other, poorer customer groups – and not for the benefit of those targeted. Other examples like artificial price increases for essential goods via ‘single servings’ (e.g. discount stores that buy in bulk to divide into pricy single units) show how fractionalizaton has been used against the less fortunate instead of empowering them.
One example is recent research into loosie (single cigarette) sales in poor areas of New York City (USA). The study found that single cigarettes were often sold for up to twice their value in a pack due to demand within these consumer groups. For anyone who has, in a moment of weakness at a bar, sought out a loosie to smoke with friends, this is demand fractionalization. Even when prices for illegal packs of 20 cigarettes averaged US$8, and legal packs sold for approx. $10 in New York City (2017-18), loosies ranged in price from 50 to 75 cents (typically) to about $1 in areas like Manhattan. This practice employs fractionalization to prey on those without a choice and is counter to its true ability to empower.
From single cigarettes to modern art, a recent article in The Economist showed that fractionalization is also being used to encourage, or lure, hip investors into art without any true financial benefit. Fractional ownership was defined as “…an investment idea more often associated with private jets and holiday homes”, but that now focuses on art, vintage cars and even sports memorabilia. Similar to what was stated above, this investing emerged after the US’ Securities and Exchange Commission (SEC) broadened its definition of “investor” in 2015. Yet, while the wider definition is great, and the growing range of investments intriguing, this fractional investing is questionable as are its returns in maintaining the spirit of empower consumers to better wealth knowledge and growth.
For modern art, which is speculative and flighty, such fractionalization is fraught with risk. Expensive artwork today has limited buyers, even for its shares, bad or no projections, a limited, if any, history of sales and, above all, no guarantee of any return. In short, fractional investing in art is focused on only one thing – risk – as even clout or delight in hanging it on your wall is fleeting for some. Such an investment is best suited to museums who, within their industry, might be empowered if assets are leased or shared, alongside profits from admission and sponsorships, but these are not available to the individual investor, especially those looking to release value in the art to grow their portfolio.
Again, flexibility and fluidity are unlikely, if not impossible, through secondary ownership trading of a Gulfstream G550 or a Banksy. These assets are illiquid, risk is rampant, insurance costly and popularity fleeting, leaving ‘investors’ out of pocket and without a painting or jet in the end.
Fractionalization: create a better future
So, we have explored how fractionalization in general and in specific instances, works today and provides some access, but not ownership or empowered wealth accumulation. In its worst cases, it is exploitative and takes advantage of those merely seeking to fill a need or leaping on a fad.
What could fractionalizaton be then?
Imagine: the free interconnectivity of financial products and assets (via smart contracts, platforms and technology) that enables individuals to pool their worth and then, in real-time, release it to further invest as well as replace value to grow their worth. This would be done within a system that sees value as fluid, holdings as flexible, actions as immediate and individuals as supported. Go further and imagine little, if any, indebtedness from Day 1 (e.g. repaying a mortgage) and, instead, value releasable from one’s home to invest in other means to build wealth. Add to quick releasing ‘value’ of all kinds – from bank accounts to insurance policies to air miles and more - to build wealth rather than saddle individuals with debt for years that benefit lenders mainly. This would mean no black and white (you have or you owe), but rather unlocking, using, replacing and reconfiguring one’s worth instantly through AI, smart contracts, globally-connected systems and other technology to create both wealth knowledge and power.
Consider Ayako. She wants to buy an apartment in Boston. She’s young and employed, but has little traditional wealth. Her holdings and status reduce her purchasing power and credit clout to borrow, as is tradition, from a bank to buy a flat. But what the bank knows she is worth isn’t her true worth. She has a life insurance policy, investments elsewhere, and even a large bank of airmiles from many business trips. Traditionally, her value to the bank is only those assets they value (similar products to what they offer, and certainly not airmiles, even if they have value). And, as such, their assessment will mean she is unlikely to qualify for a suitable mortgage unless she has a guarantor. But here is a disconnect. The bank’s assessment isn’t complete, and Ayako’s complete net worth is promising. If it weren’t for the bank’s narrow view, and if her complete assets were considered, she might qualify for the right mortgage or even pool assets to make a large down payment (and thereby reducing her mortgage and the bank’s risks). Better still, and if able to creatively draw down on her entire portfolio, she might be able to purchase the apartment outright to then replace the value withdrawn over time – when she chooses and in her preferred manner.
So, how could true fractionalization help Ayako? First, let’s look briefly at traditional home ownership. In the worst case, Ayako would get a mortgage from the bank, to be repaid over up to 30 years. This provides some security, but hurts Ayako’s present ability to grow her wealth given her repayments, most only covering interest early on. There are also potentially stressful challenges (e.g. being laid off and unable to make payments that could result in losing one’s home, bankruptcy and poisoned credit) that could complicate her life. The benefit of fixed assets and practices for Ayako are hard to see here.
Is this better? Here, Ayako diligently repays her mortgage and makes improvements to her condo that may, or may not, increase the value of the home. All along, she hopes that her apartment’s value rises over time – whether in the short-term if a move is required (e.g. marriage, work, other) or, more likely, over the long-term after she repays her mortgage in full. But is growth guaranteed in this rigid, siloed, external factor-laden and lender-sided transaction? Sadly, no. Research by Zillow in an article by Darrow Wealth Management (see here) showed that, at best, Ayako could anticipate a small return overall (see the graph below) where even house values in frontrunner Boston (USA) only rose 185% over a 23-year period (October 1997 to October 2019), while the S&P delivered a 552% return over the same period. Obvious issues aside (if Ayako invested, she likely wouldn’t have her own apartment), this is a drastically different result – one that would have been out of Ayako’s reach, but would have been better for her overall.
And here is the reason why true fractionalization is best. With fractionalization, this isn’t an either/or decision by Ayako – to buy a flat or invest in the S&P – but the ability to do both. With fractionalization, Ayako has flexibility to do what she wants at the same time and is empowered to grow her wealth with inclusion. Fractionalization enables her to, say, look at fractional home ownership (buying pre-determined shares over time) of the flat while investing in the stock market, supporting entrepreneurs and even purchasing art (if she chose to). With flexibility and fluidity, she can shift her asset pool to cover costs, invest or more, all the while building her wealth pool and, in the end, more richly contributing to society. Fractionalization enables this and more. And one final note: while fractionalization today would widen the circle of wealth accumulation, tomorrow it could easily advance to incorporate people consider ‘on the fringe’ today (those working in the gig economy for example) who will be common in tomorrow’s digital economy.
Fractionalization for Consumers
What we have come to call fractionalization has been beneficial and even detrimental to consumers. That doesn’t need to be the case in the future. It is clear that fractionalization is a path to financial freedom and heightened inclusion for consumers and, for society, wider and more fluid capital flows worldwide. The goal of empowering and then releasing the true value of individual wealth will benefit many tremendously, and we are eager to see who will lead the charge to make it a reality.
The other half: Fractionalization for Business
Yet, this is only half the story. Interconnectivity, technology (AI, smart contracts), innovative vision and a desire to encourage individual participating within financial systems could unleash the real worth of consumers. If segmentation of financial organizations and their asset classes could be overruled, and these players and their products interlinked so as to be aggregated, incredible levels of individual capital could be unlocked to override the ‘earn and spend’ mentality of old to create a ‘leverage and invest’ mindset that would be a boon for financial services. And it would go beyond this. By leveraging smart technology and supporting individual investors, providers could reduce operational costs and arbitrage as well as support astute management of the unlocking of almost unfathomably large pools of assets for creative investment and collective gain. The sky is the limit, and our next article looks at how businesses can support fractionalization to achieve such heights – and beyond.