Surprise! You invested in bitcoin

Institutional investors are not huge fans of bitcoin, but some have exposure to the digital currency without necessarily knowing it.

Venture capital and hedge fund managers are investing in bitcoin-related companies, which are showing up in institutional investors' portfolios.

To date, the digital currency is saddled with issues that could scare away even the hardiest of institutional investors, including

• the lack of a U.S. exchange or regulatory oversight anywhere in the world;


• arrests of bitcoin-related company executives by the U.S. Department of Justice for money laundering;


• collapse and bankruptcy of the largest global bitcoin exchange, Mt. Gox;


• investigations by New York state and U.S. federal regulators; and


• the sideshow aspect to the bitcoin story that includes an almost comical car chase in Los Angeles of a man believed to be Satoshi Nakamoto, the purported creator of bitcoin, by a squadron of reporters.

Despite the issues, digital currencies glow brightly in the imaginations and pocketbooks of hedge fund and venture capital management firms, which are keen to invest in digital currency-related businesses and infrastructure.

Bitcoin is not the only digital currency, but it is the most widely used.

Fortress Capital Group LLC invested $20 million in bitcoins in 2013, suffering a $3.7 million loss, according to filings with the Securities and Exchange Commission. The investment was made using the publicly traded alternative investment firm's balance sheet money, not capital from funds.

However, the bitcoin investment is a prelude to possible investment in bitcoin-related companies and infrastructure by Fortress' hedge funds, said people with knowledge of the situation who declined to be identified.

Last week, Fortress invested a combination of balance sheet and Fortress principals' capital in Xapo Ltd., a firm that provides an insured and secured online bitcoin vault. Xapo received a total of $20 million from Fortress, venture capital firm Ribbit Capital and lead investor, venture capital firm Benchmark Capital, said sources familiar with the situation.

Gordon Runte, managing director and head of investor relations and corporate communications at Fortress, declined comment.

Among the other money managers that have invested in digital currencies are venture capital firms Andreessen Horowitz, Union Square Ventures, Lightspeed Venture Partners, Camp One Ventures LLC, Core Innovation Capital, IDG Capital Partners, Canaan Partners LLC and RRE Ventures LLC, according to data provided by London-based alternative investment research firm Preqin and Seattle-based private equity research firm PitchBook Inc.

Many digital currencies, including bitcoins, are produced by people, called miners, who use mathematical formulas requiring computers to solve. (The more currency created, the harder the mathematical proofs required.) Besides bitcoin, other such currencies include litecoin, luckycoin and dogecoin.

Regardless of the name, investors are skeptical.

“Until bitcoins are more established, or even regulated, we don't anticipate any significant exposure in our holdings to them or other digital currency,” said Charles Wollmann, director of communications for the $19 billion New Mexico State Investment Council, Santa Fe.

In a recent tweet, Nouriel Roubini, called bitcoin “a Ponzi game.” Mr. Roubini is co-founder and chairman of global macroeconomic strategy research firm Roubini Global Economics and a professor of economics at the New York University's Stern School of Business.

“Bitcoin isn't means of payment as few transactions in bitcoin. And given its volatility, all who accept it convert it right back into $/e/¥,” Mr. Roubini tweeted. “Bitcoin isn't a store of value, as little wealth is in bitcoin and no assets in it. Also, given price volatility, it is a lousy store of value. So bitcoin isn't a currency. It is btw a Ponzi game and a conduit for criminal/illegal activities. And it isn't safe given hacking of it.”

Some consultants say that digital currencies have significant roadblocks to overcome before they will be a mainstream investment.

“Bitcoin is not recognized as legal tender and many financial institutions are prohibited from dealing in this digital currency,” said Matt DenBleyker, director of research for Larry Thompson & Associates Inc., a Dallas-based investment consulting firm that serves endowments and foundations.

For that reason, most “institutionalized” hedge funds and other money managers that have significant institutional assets will shun exposure, he predicted.

Overall venture investment in bitcoin-related companies was about $74 million in 40 deals, according to venture capital research firm CB Insights, New York. The highest quarterly total of bitcoin deals was in the fourth quarter of 2013, when close to $50 million was invested in 18 deals. The largest bitcoin investment during the period was Andreessen Horowitz's $25 million investment in Coinbase in December. Coinbase is an international “digital wallet” that allows individuals to buy, use and accept bitcoins.

All the growth in venture capital bitcoin investment occurred in 2013, according to CB Insights data compiled by Matthew Wong, research analyst.

Hedge funds that have invested in bitcoins include Malta-based Exante's $30 million Bitcoin Fund and Dalsa Barbour Investment Fund managed by Dalsa Barbour, according to Preqin. There is no asset figure available for Dalsa Barbour Fund. The sole private equity fund with bitcoin exposure identified by Preqin is Liberty City Ventures' The Digital Currency Fund, which has a $15 million target.

Asset owners acknowledge they might have exposure through their alternative investment portfolios, but for the most part would not comment further.

“As limited partners, we hire managers to act as fiduciaries on our behalf and put together well-diversified portfolios that oftentimes contain all kinds of interesting assets,” New Mexico's Mr. Wollmann said. “That includes a wide variety of investments, everything from pet stores to wedding gown makers, from a part ownership of pro basketball team to shares in the Blue Man Group. I'm sure at some point, one of our managers will find an attractive opportunity involving bitcoins.”

So far, any venture capital exposure in the portfolios of Larry Thompson & Associates' clients would likely be insignificant, Mr. DenBleyker said.

None of the large private equity managers that his firm works with — including TPG, Apollo Global Management, KKR and Carlyle Group — has exposure to bitcoin, he added.

But institutional investors' exposure could expand as money managers increase their investments in digital currency-related companies and infrastructure, Mr. DenBleyker acknowledged.

Abby Woodham, an analyst with Morningstar Inc. in Chicago, said she has “been relatively muted on bitcoin as an investment.”

“It's an interesting new technology but it is in the very, very new stages ... its investible merit is trickier,” Ms. Woodham said.

Bitcoins are extremely volatile; they fluctuate wildly in the course of a day, she noted. Another issue is that there are impediments to legitimacy as a currency, including the lack of a centralized mode of exchange with the collapse of Mt. Gox.

Some in the financial services industry consider digital currencies somewhere in between a currency, a commodity and a financial asset, according to a Goldman Sachs Investment Research report.

Dominic Wilson, chief markets economist and co-head of economics, commodities and strategy research in the Americas and global economics research, and Jose Ursua, a global at Goldman Sachs, opined in the report that it will be less likely bitcoin and other digital currencies will be widely used as alternatives to legal tender and “much more plausible that bitcoin eventually will have a significant impact in terms of its innovation on payments technology, by forcing existing players to adapt to it or co-opt it.”

Ms. Woodham said it could go either way.

“If the market cap were to become in the trillions of dollars ... there would be no historical data to go off of. It'd be a totally new world. Either ... in 10 or 20 years bitcoin will disappear or I will be kicking myself for not buying bitcoins,” she said.