Institutional investors in Asia have proven leery of investing into cryptocurrencies, despite their huge surge in value during 2017.
But advocates of the digital quasi-currencies argue that investments into the asset class have a role even within institutional investor portfolios because they have low correlations to other investments.
Two notable proponents are Jim Liew, an assistant professor in finance at the Johns Hopkins Carey Business School and his former student Levar Hewlett, a quantitative risk management associate at the Maryland State Retirement and Pension System.
In a report called ‘The Case for Bitcoin for Institutional Investors: Bubble Investing or Fundamentally Sound?’, released in December last year, Liew and Hewlett argued that an investment portfolio with a 2% bitcoin allocation, 59% equity weighting and 39% in bonds would have beaten a standard 60%/40% equity-bonds allocation between August 2010 and October 2017. The former would have returned 227.89% while the latter gained only 119.2% return by the end of the period, they said.
The paper’s authors admitted being concerned about using past performance as an estimate of future returns. And there is a risk that there is less than 10 years of data available for this asset. Plus, the return figures would probably look a little different if the period of coverage was extended into February 2018.
But Liew’s key argument for digital currency inclusion is the lack of correlation that they offer. Cryptocurrency provides unique diversification benefits for traditional institutional portfolios and such benefit appears to be stable over time, he told AsianInvestor.
Other cryptocurrency believers claim the quasi-currencies can be traded and analysed in sophisticated ways.
David Demmer, chief executive and chief investment officer at CryptAM, a cryptocurrency portfolio manager, told AsianInvestor there are strategic ways for investors to generate value, but they require fundamentally different analysis from traditional assets.
“There is no discounted cash flow methodology, there is no income stream like for fixed income, there is no yield per se. So when you are looking at the fundamentals, you have to look at the strength of the development team, the real-life usage cases and adoption of particulars. You also have to look through the marketing to see how these will be accepted,” he said.
BLANKET OF SPECULATION
Yet even crypto adherents cannot deny the blanket of speculation has settled over cryptocurrencies. That has institutional investors nervous, especially pension funds.
National Pension Service (NPS), Korea’s largest institutional investor, got into hot water after its domestic alternative investment division admitted to having invested W2.6 billion into two external funds, which had bought into four cryptocurrency-related businesses.
“While the government calls digital currency investment gambling and tells the public to not invest, government agencies such as the National Pension Service are making indirect investments,” said lawmaker Lee Chan-yeol, according to the Korea Joongang Daily on January 29.
Avoiding such controversy partly explains why Tsay Feng-Ching, director general of Taiwan's Bureau of Labor Funds, is staying away from cryptocurrencies. “We do investments, not speculation. There is just a fine line between investment and speculation, but at present, if 90% [of demand for cryptocurrencies] is speculation, it is an issue,” he said.
Even the family offices of Asia’s wealthy have lingering concerns over cryptocurrency investments. Stephen Pau, chief investment officer of Hefeng Family Office, told AsianInvestor that they are hard to explain to the backing families, in part because of their short track record and also because there is not much research on them.
“When we educate investors we need some historical background but there is little that we can talk about….Without history it’s difficult to extrapolate its future trend,” he said.
WAIT AND SEE
After their rough time in late January and early February, it’s little surprise that the appeal of cryptocurrencies has taken a dent, and further disinclined institutional investors from putting money into them.
However, they could gain appeal in the future. The creation and proliferation of benchmark indexes and derivatives would help to reduce their speculative nature, and raise their appeal with professional investors, said Tsay.
CryptAM is working to do exactly that; create cryptocurrency-based indices which asset managers can use to create funds.
But it will take time. Asia’s institutional investors appear content to wait and see what the future brings to the world’s budding digital currencies. “Maybe in the future [cryptocurrencies] can be a convenient and safe medium of exchange and can then be a financial asset,” said Tsay. “But we are still not sure yet.
This story marks the second in a two-part focus on cryptocurrencies, and is adapted from a feature in AsianInvestor's February/March magazine. Please click here to read part one.