By Simon Zais, CAIA, and Daniel Kerney, are both consultants with Capco.
1602 was a watershed year. Bartholomew Gosnold became the first European to explore Cape Cod, Shakespeare published The Merry Wives of Windsor, and the Dutch East India Company issued stock to fund its various adventures around the globe. And while the Bard’s deep tracks certainly merit the occasional re-reading, when examining ripples through history, the invention of corporate stock and the world’s subsequent adoption prove to be the more effectful butterfly.
Today, the world is witnessing a similar introduction: digital assets. Irrespective of the debate on any particular token’s fair value, this new asset class is an asset class. Entirely distinct from existing asset classes and with limited correlation, digital assets’ adoption into the mainstream financial framework is as inevitable as was 17th century corporate stock.
Forward-thinking wealth managers now find themselves asking “If my client wants crypto exposure, what options can I provide them?” Currently, the market presents a handful of options through several routes.
The first and most obvious is direct cryptocurrency ownership.
While most large wealth managers have not yet started offering this service to their high-net-worth clients through in-house wallets, many are exploring the possibility. Exempting a few smaller niche firms, the majority of wealth managers are still in the position of building externally held cryptocurrency positions into financial plans.1 In this situation, even while losing wallet share to crypto third-parties, wealth managers can add significant value by providing thoughtful and thorough due diligence on providers, and advice around the assets.
The next rung on the ladder is investment in digital asset funds. Where the large wire houses have shied away from direct cryptocurrency ownership, they have leaned into offering crypto funds to certain accredited investors. Morgan Stanley,2 Goldman Sachs,3 and JP Morgan4 have all publicly announced offerings of these crypto funds. All these funds are actively managed and may not be a substitute for clients looking solely for crypto beta exposure, but for a client who may be less comfortable with the prospect of personally managing a wallet, these funds provide the familiar comfort of institutional underwriting.
For clients and wealth managers interested in pursuing certain trading strategies, the CME group has listed futures for both Bitcoin and Ether. Futures strategies can be complex and risky, but for discerning ultra-high-net-worth clients and the knowledgeable wealth managers, these products could open a world of leverage and flexibility.
Some clients may balk at the level of complexity inherent each of the aforementioned strategies. Others may not meet the accreditation requirements for investment in certain funds or futures. Luckily, as digital assets in general and cryptocurrencies in particular gain market acceptance, there are three familiar products currently available — regardless of accreditation or sophistication —which can be provided with a crypto twist.
The most perennial of these products to investors is stock in companies within the digital assets space. These companies can range from focused entirely on crypto, like Coinbase, to legacy companies with exposure to the digital asset ecosystem, like Nvidia.
Another familiar product wealth managers can deploy to bring crypto exposure to clients is a digital assets ETF. Many “digital assets” ETFs currently exist and with significant overlap. Some ETF managers disguise traditional tech exposures under cryptocurrency marketing; wealth managers can prove their mettle with an examination of fund component companies to sniff out this potential ruse.
Finally, the product for which investors and wealth managers have been scanning the horizon—the Bitcoin ETF.5 Bitcoin ETFs, as currently being proposed, could come in two forms. Either a direct holdings ETF like GLD (backed by physical gold in a vault), or a futures ETF like USO (rolling front-month oil futures). At the time of this writing, the SEC has allowed the listing of one Bitcoin futures ETF, with more funds’ applications currently pending. Wealth managers can once again demonstrate value by explaining the structural peculiarities of each, how their unique risk profiles fit into unique portfolios, and how exposure through an ETF differs from direct ownership of the underlying Bitcoin.
While a handful of companies have petitioned the SEC for approval of ETFs directly holding Bitcoin, to date regulators have either rejected or postponed decisions on all applicants. SEC concerns around the mechanics of such a product, including (but certainly not limited to) valuation, liquidity/redemption, volatility, custody, and potential manipulation, should not be construed as doubts of commercial and retail demand. Investor and advisor desire for cryptocurrency exposure combined with the both the general popularity of the ETF vehicle, and the evergreen demand for cheap beta will provide a solid tailwind to fund flows, should the product come to market.
Wealth managers confronted with crypto-desirous clients find themselves at the trailhead. Laid afield are the twin choices of engagement and recommendation. Just like any emerging asset, from the first simple Dutch stock, to elaborate structured products, digital assets present a unique opportunity to the wealth managers able to provide prescient advice. And knowing the products is the right first step.
About the Authors:
Simon Zais is a consultant with Capco specializing in Wealth Management. He has experience in both the front and back office, using his broad experience to execute meaningful change across organizations. Simon holds a degree with honors from Baruch College and is a CAIA charter holder. He lives in Connecticut with his wife, son, and two dogs.
Daniel Kerney, is a Management Consultant at Capco, within the Private Wealth and Asset Management Domain. Prior to Capco, Daniel was a Business Consultant at Oracle, building financial applications for clients. He holds a BA in Law and Business from the University of Waterloo.