Crypto has been something of a cult investment. Believers are committed to it, unreservedly, like any good cult members should, propagating its freedom and how crypto can break state monopolisation of the financial sector. Non-believers, however, have generally stayed away, not wanting to be burned by its unpredictably.
Yet is there a case for presenting it as a valid form of institutional investment?
Its evolution has been the complete reversal of the normal development of an investable asset class. Usually investments begin at an institutional lab, fulfilling some institutional portfolio need, and gradually feeds through and down to the retail sector.
However, crypto has been created from the opposite end of this spectrum, emerging and evolving as a form of retail investment, and expanding out from there.
Matteo Dante Perruccio, senior adviser at 3iQ Capital Management, hones in on the evolution of crypto. “If you think of any other investment innovation, whether that be derivatives or hedge funds, they generally came to a more sophisticated investor base and then made their way down and were simplified for the retail investor,” he said.
In addition, that retail focus brought with it numerous challenges. “When an investment is on a retail level it receives a lot more visibility and coverage, which has happened to crypto,” Perruccio says.
Advocates of crypto say the market is now highly developed, offering institutional investors opportunities in which to invest, if chosen carefully. There is no doubt that there are different ways to invest in crypto.
Rise of the crypto ETF
Crypto exchange-traded funds (ETFs) are one such avenue. ETFs are predicted to transform the crypto investment market, becoming an important part of pension fund investments.
In fact, blockchain expert Fiorenzo Manganiello sticks his neck out by predicting that crypto could form 5% of pension fund portfolios by the end of next year.
There is no doubt that crypto has momentum behind it, especially via this ETF route. One example is the report in the Financial Times that Blackrock’s spot bitcoin ETF has accumulated $16.7bn (£12.8bn) of assets since it launched in January, suggesting a great deal of investor interest.
And this looks set to be the start. More and more crypto ETFs are due to enter the market, with ‘Ether ETFs’ gaining full and final approval from the US’ Securities and Exchange Commission (SEC) over the summer.
Manganiello therefore believes regulatory greenlights such as this will play an important role for more institutional investors, such as pension funds, to view crypto as a greater viable investment asset.
For Manganiello, it’s only a matter of time until these institutional players muscle into the crypto market. “Crypto ETFs have been given the regulatory green light and, for an asset that has long been considered volatile and novel, it’s a big step. “Crypto is beginning to prove the critics wrong, it’s been given regulatory legitimacy,” he says.
He also gives a nod to its retail history. “I won’t deny that crypto has traditionally been seen as a retail market. But, with Blackrock stepping in and growing its own spot ETF so quickly, it won’t be long until other institutions take the leap and invest in crypto. The Ether ETF approval will only be a catalyst.”
Put it in your pension
Expanding out on this positive outlook Manganiello looks at the crypto investment case. “Crypto can be highly profitable – and institutional investors will definitely look to take advantage of it as they seek to diversify their assets,” he says. “That’s why by the end of next year we’ll see crypto ETFs form a decent chunk – at least 5% – of pension fund portfolios.”
That seems a decent jump, especially from what is a standing start. And with various numbers being bandied around, I put the institutional investor interest in crypto to the test by enquiring with some UK pension fund holdings of crypto. I found a regular response: nothing to see here.
This does suggest that the noise surrounding crypto could still be noise, at least for a key part of the institutional investment world. Based on that, on what grounds has Manganiello concluded that pension funds are set to embrace crypto? “We have seen a huge movement from institutional money into this space,” he says.
“At the end of the day, it’s incredibly important for institutional investors to stay ahead of the curve. They have to adopt what I’d call a ‘millennial savviness’, an approach that embraces emerging, innovative alternative investments – and isn’t bogged down with preserving the status quo,” he says.
“With crypto, it is no different, institutional investors have to be ready to consider crypto as an asset – and especially with crypto ETFs quickly gaining approval,” he adds.
Although the investment numbers in crypto cited thus far look impressive, Manganiello notes that about a fifth of money flowing into crypto ETFs is from institutional investors, so there is room for a great deal of improvement from an institutional investor perspective.
Scratching the surface
ETFs are not the only route to crypto for institutional investors. “There are a variety of ways in which to engage with and get exposure to digital assets,” says Dovile Silenskyte, director of digital assets research at Wisdom Tree.
“As investors have shown interest in investing in crypto assets, ETPs (exchange-traded products) represent a good route-to-market option allowing for convenient and safe access to this asset class,” she added.
There are other benefits of ETPs that offer an appealing route to institutional investors, Silenskyte says. “Most crypto-asset ETPs give investors institutional-grade trading and custody services, addressing investor concerns such as hacking or theft of the private keys, or not being able to access liquidity across various crypto exchanges,” she adds.
“Most importantly, crypto ETPs can seamlessly plug in to existing trading and brokerage platforms,” Silenskyte says.
Institutional investors can now access crypto ETPs via some of Europe’s most popular exchanges including the London Stock Exchange, SIX [the Swiss Exchange], Börse Xetra [the German electronic exchange] and Euronext in Amsterdam and Paris.
One such market debut is particularly important, Silenskyte says. “The London Stock Exchange listings is a significant step forward in the legitimisation and relevance of the asset class for UK professional investors.”
There is genuine context to that statement. The launch of US spot bitcoin exchange-traded funds in January has been the most successful ETF launch ever. “We could be scratching the surface when thinking about their growth potential after such an impressive start,” Silenskyte says.
An historical year
These are therefore defining times for crypto. “2024 has been historical for crypto currencies,” Silenskyte says. Supporting the successful crypto narrative Perruccio adds: “Crypto is the best performing asset in 2024.”
This is borne out by investor interest. Investor appetite has increased this year, demonstrated by net inflows across crypto ETPs, for example, of nearly $20bn (£15.3bn) globally in the year-to-date. Since the start of the year, assets in crypto ETPs have trebled from a little over $30bn (£23bn) to more than $90bn (£69bn) due to these flows and overall market moves.
It does seem crypto is breaking records in all areas which could be used as evidence of how popular and important it is becoming amongst investors, or, for those with good memories, it could have worrying comparisons to the tech boom-and-bust of the early 2000s.
Whichever scenario you think is the most accurate, there is no doubt that the digital assets ecosystem continues to grow and diversify, which creates new opportunities that may be of interest to investors.
“It boils down to asset allocation and risk management frameworks to determine which levels of involvement are warranted in a broad portfolio context, but we believe digital asset have a place in most portfolios, even if in small amounts,” Silenskyte says.
As crypto is such a young asset class and because many investors are still relatively unfamiliar with it, it would be easy to think that the neutral positioning is 0% investment and that anything above zero is overweight. But this, Silenskyte says, is not the case.
“A good assessment of the neutral positioning of an asset in a multi-asset portfolio is to look at the market portfolio, that is the portfolio that simulates the totality of all listed, investable assets access,” she says.
The total market cap of listed, investable assets sits at around $200trn (£153.6trn), so is substantial. With a market cap of more than $2trn (£1.5trn), crypto represents just 1% of that. This market is now of a similar size to high-yield bonds, inflation-linked bonds or emerging markets small caps.
Volatile market
The neutral position therefore for multi-asset portfolio managers is to invest around 1% of their portfolio assets in bitcoin and/or other crypto. “1% is the rational choice for investors in the absence of a strong, supported investment thesis against crypto assets: for example, if portfolio managers decide not to invest in European equities, they usually have clear reasoning for such decisions,” Silenskyte says.
And looking at it further within a portfolio, Silenskyte adds: “It has been shown that integrating crypto into diversified multi-asset portfolios offers potential benefits in enhancing the risk-return profile of those portfolios.”
Indeed, the big concern about crypto is its volatility. Responding to this, Perruccio puts forward a defence. “In any asset allocation there has to be a risk-return profile. And volatility in of itself is not a bad thing,” he says. “It is only a bad thing if the return doesn’t justify it. The volatility in crypto can be a nice return enhancer. Where else are you going to get that?”
And another hurdle crypto has to overcome, thanks in part to its retail history, is the perception as something that works on a more trading level than as an investment.
But there are traditional investment attractions for institutional investors. “You can buy and hold, you don’t need to trade,” Perruccio says. “People do focus on the volatility of crypto, but if you look at its performance year-on-year you will have done pretty well indeed.”
So what should the investor exposure be? “There are different types of exposure,” Perruccio says. “If you put in 3% or 4% of digital assets in your portfolio you can increase the Sharpe ratio pretty significantly. It wouldn’t be a core holding. Investors should be looking at 3% to 5% in large-cap crypto. It can sit alongside equities,” he says.
Large-cap crypto is usually defined as having a market cap of more than $10bn (£7.6bn), so pretty substantial.
This size of market cap stands out for two reasons, Manganiello says: they are considered to be safer investments because they have more liquidity and therefore can better withstand market volatility. And two, they tend to have a history of growth, vitally important for investors.
Perruccio also makes the point that crypto should be seen in a greater historical context, in terms of the development of other investments. “In the early days of emerging markets, institutional investors would never contemplate 15% to 20% of their portfolio in emerging markets. It was 1% to 3%. That has since changed.”
Will investors therefore follow the emerging market trend and increase their allocation to crypto? “Possibly, who knows,” Perruccio says, giving an indication of the uncertainty of how the market, and investors approaching it, will or will not address crypto. But there is another reason for institutional investors to consider crypto.
“If institutions only invested in the big guys and more established stuff they would significantly underperform a lot of the market,” Perruccio says.
“It is a case of coming out of your comfort zone and looking at the opportunity of crypto,” he adds. “So what I would say to institutional investor chief investment officers is learn about it. There is a lot of peripheral noise, it is young, but it is here to stay.”
Perruccio concludes on a positive note, saying that the future looks bright for the asset class. “Crypto is the future of institutional investing. Therefore, can institutional investors not afford to be invested in the future?”
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