More funds testing water on crypto-related assets

Institutional investors, including public pension funds, have begun taking bets on fledgling funds, which invest heavily in cryptocurrency and blockchain-related companies.

But these funds also could invest directly in cryptocurrencies as well, which some industry sources argue are not a viable investment option for institutions, primarily due to volatility and valuation concerns.

In Virginia, the $4.2 billion Fairfax County Employees' Retirement System and the $1.5 billion Fairfax County Police Officers Retirement System became the first known public pension plan to commit to a dedicated fund that invests primarily in blockchain technology firms. The investments were "deliberately sized to be a small portion of each system's assets," Jeff Weiler, the executive director of Fairfax County Retirement Systems, wrote in a February note published on the system's website. The employees' fund allocated $10 million and the police fund $11 million, mandates representing less than 1% of each fund.

Both investments were made in the Morgan Creek Blockchain Opportunities Fund, managed by Morgan Creek Digital Assets, a subsidiary of Chapel Hill, N.C.-based Morgan Creek Capital Management LLC.

While 85% of the Morgan Creek fund is invested in blockchain technology firms, up to 15% of the fund can be invested directly into cryptocurrencies, Mr. Weiler wrote, adding that the fund currently "has no exposure to any cryptocurrencies."

Since June, other unidentified institutions, including a university endowment, hospital system, insurance company and private founda- tion have invested in the fund, said New York-based Anthony Pompliano, founder and partner at Morgan Creek Digital Assets.

Every investor in the fund is under the same structure, where up to 15% of the fund can be allocated to liquid cryptocurrencies, such as bitcoin, Mr. Pompliano said. The Fairfax plans made their allocations to the $40 million fund at the end of the year, he added.

"The fundraising target was $25 million, and we oversubscribed to $40 million. The fund is done fundraising and will not take any more investors," Mr. Pompliano said.

"That 15% is kind of an artificial cap because we want to make sure we are sizing the liquid investments inside of the portfolio according to the risk-return profile that liquid cryptocurrencies present," Mr. Pompliano said. Morgan Creek believes that certain cryptocurrencies, "although they are volatile, have enormous upside and, therefore, we want to make sure that we gain exposure to it. But we want to size it correctly within the portfolio."

The University of Michigan's $12 billion endowment committed $3 million in June to a dedicated fund investing in crypto-technology companies, which was created by Menlo Park, Calif.-based venture capital firm Andreessen Horowitz, according to agenda materials from the university's Feb. 21 board of regents meeting.

The fund, CNK Fund 1, also received approval for a follow-on investment of an undisclosed amount, the documents show. Follow-on investments do not require approval, only a report to the board, a university spokesman wrote in a February email, declining to provide further information.

Last year, the $29.4 billion Yale University endowment, New Haven, Conn., run by CIO David Swensen, who is known for his bold approach in alternative investing, allocated an undisclosed amount to two cryptocurrency funds, according to an October Bloomberg News report. Mr. Swensen did not respond for comment, and a spokesman for the school declined to confirm whether investments were made into cryptocurrency funds.

Giorgio Carlino, a managing director and CIO of the global multiasset team at Allianz Global Investors, New York, said in a phone interview that there are "too many risks involved" in investing in cryptocurrencies to date, with the primary risk being valuation. "As an institutional investor, you should not, you could not actually, explain a position in bitcoin … or any other crypto in your portfolio as an asset allocation."

"The valuation of the cryptocurrency is not possible as of today," he said. "They have no income, there's no intrinsic value, there's no guarantee by a state or a central bank. It is an interesting concept and I'm fascinated, but it's not an investment." But Mr. Carlino does see a case for gaining an exposure to the cryptocurrency industry itself, by way of venture capital investments targeting firms banking on the future of blockchain or so called cryptoassets. But he describes even these investments as "high risk."

"There are different ways of using cryptocurrencies that are, I see in the future, absolutely there. … J.P. Morgan has made a gigantic investment themselves," he said.

Last month, J.P. Morgan Chase & Co., New York, became the first U.S. bank to create and successfully test a digital coin representing a fiat currency. "JPM Coin" is a prototype which the bank plans to use to enable payment transfers between institutional customers, such as banks and broker-dealers, using blockchain technology, the company said in a Feb. 14 announcement on its website.

The development comes despite J.P. Morgan Chase CEO Jamie Dimon's noted skepticism of bitcoin, having called it a "fraud," and going as far as to say he would fire any employee trading the cryptocurrency, Bloomberg News reported in September 2017.

Earlier this year, Andreas Utermann, AllianzGI CEO and global CIO, offered his own thoughts on cryptocurrency investing in a LinkedIn post, writing: "As an asset or a currency ... the value of a cryptocurrency is in the eye of the beholder. This makes cryptocurrencies entirely unsuitable for investing in."

While some in the industry have issued a strong word of caution on framing cryptocurrencies as a legitimate investment option, at least to date, investment consultant Cambridge Associates LLC, Boston, has signaled that institutional investors should be exploring opportunities in the cryptocurrency and broader blockchain industry.

Cambridge published a white paper Feb. 19 that explained various types of "cryptoasset investments," including ways investment managers can gain exposure – from purchasing liquid cryptocurrencies, like bitcoin, to making investments in companies "whose returns are connected to the growth of the asset class," as the "liquidity of these investments is similar to traditional venture capital investments," the paper said.

"Although the crypto industry remains in its infancy, we think institutional investors should begin exploring it," the paper noted.

Cambridge cautioned that an allocation to cryptoassets exceeding 1% of a portfolio on a look-through basis "does not appear prudent, even for those comfortable assuming the very high risks involved," the paper said.

Marcos Veremis, a Cambridge managing director in Arlington, Va., and co-author of the paper, confirmed that many funds which primarily invest in cryptocurrency or blockchain companies also allow direct investment in cryptocurrencies.

"We see many funds build in the option to invest in cryptocurrencies, such as bitcoin," he wrote in an email.

Cambridge said that, despite challenges such as very high risks in the space, "we believe that it is worthwhile for investors to begin exploring this area today with an eye toward the long term."

Other consultants, including Aon Hewitt Investment Consulting Inc., Callan LLC and Mercer Investment Consulting LLC, have not given institutional clients the go-ahead regarding such investments, though they continue to monitor the field.

"Cryptocurrencies are themselves in a bear market and it would be dangerous to extrapolate future results from a past record that has really shown the ups and downs of this (potential) asset class with bubble-like qualities," said Zornitza Taleva, a senior hedge fund consultant at Aon Hewitt, New York. "We are skeptical of the role of crypto funds in a global institutional portfolio."

Mark Wood, Callan vice president and U.S. equity investment consultant, said in an April 2018 research paper that the firm "does not recommend our clients invest in cryptocurrency strategies due to concerns over asset security, liquidity, unclear tax implications and heightened volatility."

Mr. Wood said in a February email that Callan still holds this view, but that its stance was "targeted at a direct investment in crypto tokens (or funds that invest in a basket of tokens) — we remain cautious given the heightened volatility, liquidity concerns, high fees and evolving custodial infrastructure."

Mercer also does not recommend investment in cryptocurrencies or, so-called "cryptoassets," including venture capital funds that look only at that sector, said Matt Scott, a strategic research specialist based in Bristol, England.

Mercer's main concerns are related to volatility, Mr. Scott said, but there are also other factors such as environmental, social and governance issues. Some cryptocurrencies have been used "primarily for illegal transactions, like purchasing narcotics or circumventing a country's capital controls," for example, he said.