It’s harder than ever to dismiss Bitcoin as a fad or a fraud, and even longtime skeptics have come around to at least a grudging acknowledgment that cryptocurrency isn’t going away. Digital assets are rapidly entering the mainstream, and financial advisors are fielding myriad questions from clients about this rapidly growing asset class.
Big-name investors like Paul Tudor Jones and Stanley Druckenmiller revealed Bitcoin allocations in 2020, while institutions including Fidelity Investments and Morgan Stanley have made it possible for advisors and wealth management clients to purchase Bitcoin on their platforms.
But for all the hype, adoption by professional investors remains in the early stages. According to a recent Bitwise Asset Management survey, about 9% of financial advisors currently have an allocation to crypto assets in client portfolios, while 24% said they owned them in their personal portfolios. Four in five financial advisors said their clients asked them about crypto assets in 2020, and 17% said they planned to invest via client portfolios in 2021.
“We are approaching the tipping point,” says Ric Edelman, a longtime advisor who now runs the RIA Digital Assets Council, a resource for educating advisors about blockchain technologies and cryptocurrencies. “In the past several years, the question was, ‘Why are you investing in Bitcoin?’ The question is now becoming, ‘Why aren’t you?’ ” Edelman says.
Snappy comebacks aside, there are many reasons to invest in Bitcoin—and some reasons not to. The rationale for investing is the beginning of the road map for how to approach incorporating Bitcoin and other cryptocurrencies into a portfolio.
Some buyers think of Bitcoin as a venture capital–like bet on an emerging technology that will transform the way people pay for goods and services and transfer money internationally—like buying an upstart Visa (ticker: V) or PayPal Holdings (PYPL) in the early days of the credit-card or digital-payments boom. Others see it more similar to inflation-countering “digital gold,” while some are looking to increase their portfolio’s diversification with an uncorrelated asset. Whatever the reason, a few things to keep in mind are:
Start small. No matter the rationale for buying cryptocurrency, starting with an allocation of 3% or less gets investors ready to stomach some volatility. Swings of 10% or 20% or more in the span of a week are hardly uncommon for Bitcoin. For an asset that volatile, it doesn’t take a large allocation to have a significant impact on a portfolio’s return. And in a worst-case scenario, should Bitcoin’s value fall to zero, an allocation of a few percentage points won’t ruin the investor or client.
The upside, meanwhile, could be much, much greater. The return of more than five million percent since Bitcoin’s inception in 2009 won’t be repeated, but bulls’ long-term targets are still exponentially higher than today’s price. Whereas forecasts of long-term stock returns are given in terms of single- or double-digit percentage growth per year, Bitcoin forecasts tend to be quoted as a “5x” or “10x” return.
IEQ Capital is a California-based asset manager and financial advisor with $12 billion in assets under management. The firm recently started adding a 1% to 3% allocation to Bitcoin for clients who can afford the risk and are comfortable with holding crypto assets. IEQ now has $80 million in Bitcoin across all of its portfolios, which its co-CEO Eric Harrison anticipates will double or triple in the not-too-distant future.
Harrison is bullish on Bitcoin’s price continuing to rise as more institutions and investors adopt the cryptocurrency. He notes that total supply is capped, and that a large proportion of Bitcoins haven’t been exchanged in over a year. “The total number of Bitcoins that actually trade—what you can consider the float—is a fairly small number,” Harrison says. “As institutions, corporates, and [money managers] step up their Bitcoin purchases, you end up with a supply/demand mismatch that’s potentially pretty sizable.”
A net inflow of $93 million into Bitcoin can cause a 1% increase in its price, according to a BofA Securities analysis in March. That’s less than 1/20th of the inflow required to move gold by the same amount.
Institutional acceptance doesn’t mean there won’t be another crash in the price of Bitcoin. It’s still a risky asset with an uncertain future, due to a bevy of potential pitfalls—not limited to government regulation or technological obsolescence.
Consider its noncorrelation. Without cash flows or other fundamentals to derive value, Bitcoin’s future price trajectory will remain a topic of debate. But outside of periods of intense cross-market stress like in March 2020, its price should remain uncorrelated to whatever stocks, bonds, or commodities are doing. In other words, there’s a potential portfolio-risk-reducing, and Sharpe-ratio-increasing, diversification benefit to having a Bitcoin allocation, even if its future returns can’t match its past trajectory.
Versus the stock market, Bitcoin had a correlation of just 0.11 from the start of 2018 through November 2020, according to data from Leuthold Group’s chief investment strategist, Jim Paulsen. That compares with bonds’ and stocks’ -0.24 correlation and gold’s and stocks’ 0.31. (1 is a perfectly positive correlation, -1 is a perfectly inverse relationship, and 0 means no correlation whatsoever.) Bitcoin also had a correlation with bonds of under -0.01 in that same period.
Embrace volatility. Bitcoin’s immense volatility has kept many investors away from crypto assets in general, but there’s another way to think about that volatility.
“Many people look at the volatility of Bitcoin and think, ‘I don’t want that.’ I disagree,” says Paulsen. “Because it’s so dramatically volatile, you can exploit it [by rebalancing often].”
Paulsen and Edelman both advise having a hard-and-fast rule about keeping a portfolio’s Bitcoin allocation on target. Take a portfolio with a target 2% position as an example. When Bitcoin’s price drops and its weight in the portfolio falls to 1.5%, an investor should buy back up to 2%—and likewise sell back down to 2% when Bitcoin rallies and its portfolio weight rises to 2.5%. As long as Bitcoin’s overall trend remains up, it’s a decent strategy to win over the long term. It takes advantage of the volatility of Bitcoin, rather than treating it solely as a risk. The downside is that the strategy may require trading often, and commissions could add up.
Investors can also take a dollar-cost-averaging approach: Rather than investing the full 2% of their portfolios in Bitcoin in one trade, build up that allocation over three, six, or 12 months to smooth out the volatility that’s likely to occur over that span.
As the asset class matures, Edelman says its volatility will decline. “As there’s greater institutional ownership of Bitcoin and the price rises, it is reasonable to expect that volatility will be reduced,” he says. “That is true of any asset class or emerging investment you care to look at. Its neophyte elements will begin to smooth out.”
Choose your products. In the meantime, there’s still a logistical hurdle for advisors looking to get into crypto-asset investing on behalf of their clients. Adding Bitcoin to client portfolios, charging fees on it, and fulfilling back-office record-keeping and tax-reporting requirements isn’t as simple as buying a given stock or bond. But things are moving in that direction.
Fidelity was the first major institution to offer Bitcoin on its platform for advisors and money managers—supporting custody, trade execution, and reporting functions—and plans to add ether, the coin based on Ethereum blockchain technology, later this year. It also recently filed with the Securities and Exchange Commission to launch a Bitcoin exchange-traded fund.
“Our core focus is to provide institutions with the ability to safely store and transact digital assets of all types,” says Tom Jessop, president of Fidelity Digital Assets. “It’s a very familiar experience for a traditional institution….Most of the interest now is on Bitcoin, and that’s where we started, but our long-term view is that we’re agnostic as to what the assets are.”
Morgan Stanley recently made Bitcoin funds available to certain wealth management clients, while JPMorgan Chase (JPM) is reportedly planning new crypto-related services. Bank of New York Mellon (BK) said in February that it would soon offer custody of Bitcoin and other crypto assets for its clients, following a similar move by Northern Trust (NTRS). The soon-to-be-public cryptocurrency exchange Coinbase has also offered a regulated crypto custodian service for institutional investors since 2018. Many other upstart crypto-only exchanges won’t meet the compliance and custody requirements of most advisors.
And there are existing over-the-counter options for advisors whose mandates allow them to buy assets not listed on traditional exchanges. Grayscale offers a number of publicly traded trusts, the two largest being the Grayscale Bitcoin Trust (GBTC) and the Grayscale Ethereum Trust (ETHE)—while Bitwise offers a fund that tracks a basket of the top 10 cryptocurrencies by capitalization, the Bitwise 10 Crypto Index fund (BITW). Those should be available in most brokerage accounts like almost any other security, with daily liquidity. But their structure resembles mutual funds more than ETFs, and it’s worth noting that Grayscale’s 2% management fee on its cryptocurrency trusts is meaningfully higher than most passive vehicles on the market.
Some advisors can also take on crypto exposure via separately managed accounts or turnkey asset management programs, while high-net-worth or accredited investor clients have a variety of other options available to them, as well. “There’s really no reason for an advisor to say, ‘I have to wait for an ETF,’ ” says Edelman. “Because they don’t anymore.”
Write to Nicholas Jasinski at [email protected]
