Blockchain-powered breakthrough on mutual fund

Dechert partner Timothy Spangler well remembers standing next to a whiteboard on Franklin Templeton Investments’ San Mateo campus in California, about three years ago. He was with some of the asset manager’s senior executives.

The hype about blockchain technology — which instantly creates secure digital records on a distributed database — was close to fever pitch. Experts across the world were speculating on its potential to disintermediate old financial services systems where simple jobs can take days.

Franklin Templeton wanted in, and executives had gathered to brainstorm ways to exploit blockchain. But, unlike many other companies hunting for a blockchain application, Franklin Templeton — which has $1.5tn of assets under management — happened on an idea it would actually execute. It was also one it predicted could generate big savings for clients.

“We came up with the idea of a mutual fund whose shares were built on a blockchain,” recalls Spangler. It resulted in Franklin Templeton’s OnChain US Government Money Fund — the first mutual fund to use blockchain to process transactions and record share ownership.

We made it very clear that this was not about trying to sneak bitcoin and crypto into a money-market fund

Mutual funds, which pool investments across low-risk assets such as government bonds, are owned by almost one in two households in the US. Traditionally, they are administered through brokerages, but redeeming holdings is not instant.

Spangler says a mutual fund powered by blockchain can trade 24 hours a day, 365 days a year, so “you don’t have to wait 24 hours to have a human being shuffle the paper around”. It will also result in a more secure system and a “highly significant decrease in fees”, he says, though he admits the level of those savings has “yet to be determined”.

The blockchain technology that powers transactions for the OnChain fund is the only feature that makes it different from the many similar funds Franklin Templeton has been creating and selling for decades. Still, securing approval took months of extra negotiating with regulators.

“We made it very clear that this was not about trying to sneak [cryptocurrency] bitcoin and crypto into a money-market fund,” explains Spangler. He says the Securities and Exchange Commission, the regulator that licenses such products, saw “clear blue water between blockchain technology in the abstract and highly volatile cryptocurrency being put into retail [investment]” products.

Franklin Templeton stressed that the only thing changing was how records were kept and how transactions were done. The move had already been made from paper ledgers to spreadsheets stored in the cloud. Using blockchain technology was a “minimal change”, it argued.

“If you see it as just the next tech upgrade, it’s not nearly as frightening in that sense,” Spangler adds.

The SEC was persuaded — after an approvals process that took significantly longer than the four to six months that is typical for new products. The OnChain fund launched in pilot form in April, with $1.4m of seed money and investment from Franklin Templeton’s US employees.

Its gross expense ratio is 3.5 per cent, which is far higher than the 0.52 per cent on the manager’s $3.3bn US Government Money Fund, partly reflecting the blockchain fund’s pilot status. The fund is also yet to benefit from the cost savings of blockchain because it is maintaining traditional records in parallel.

If you see it as just the next tech upgrade, it’s not nearly as frightening

Spangler thinks the market does not realise how disruptive OnChain could be, and sees potential for it to pave the way for other funds, from Franklin Templeton and rival asset managers. “A number of my clients believe that . . . in a small number of years the near entirety of transactions in financial assets will either occur on the blockchain or be blockchain facilitated,” he says.

Spangler adds that Franklin Templeton’s work with the SEC means approving new blockchain-based funds will take only about 10 per cent longer than for traditional funds.

Asset managers could also look at putting existing funds — or part of them — on a blockchain infrastructure. In one approach, an asset manager could carve out units of an existing fund, put them in a digital depository and create the digital equivalent of a depository receipt for ownership. Those receipts could then trade on the blockchain.

“I don’t think any of this is flying cars,” Spangler says. “Every year from now is going to be marked by a step change in the permeation of blockchain in financial services.”

He is not worried that consumers might find the idea of blockchain-based funds too radical. “We buy cars without having any idea how the engine runs,” he says. “No one is being forced to buy blockchain based products. It’s an opt-in process.”

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