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Pension funds, the most conservative institutional investors, are now taking a closer look at the burgeoning crypto and blockchain sector.
There are several compelling reasons why pension funds should avoid investing in the cryptocurrency and blockchain space. The industry is too young, too volatile, and overly technical. Furthermore, the sector’s rules and regulations have yet to be established.
However, the fixed-income financial instruments that pension funds typically favour, such as long-term government bonds, are barely paying anything these days, leaving the traditional custodians of employees’ retirement funds in a quandary: In a world where inflation is looming, where can you find investment yield?
It is perhaps not surprising, then, that pension funds — the most cautious of institutional investors — are now taking a closer look at the burgeoning crypto/blockchain sector.
“Family offices led the charge into crypto funds several years ago, but we’ve seen increasing interest from pensions, and there are many pensions that now have exposure to crypto,” Stephen McKeon, a finance professor at the University of Oregon and a partner at Collab+Currency, said.
“We’ve seen increased interest from pensions” in the past year, added Christine Sandler, head of sales, marketing and research at Fidelity Digital Assets — part of an uptick among all institutional segments — “which we believe reflects the growing sophistication and institutionalization of the digital assets ecosystem, combined with a strong macro narrative driven by response to the pandemic.”
Pension funds tend to be “more conservative, risk-averse investors relative to other segments,” according to Sandler, and they mostly favor investments that have exhibited long-term growth and low volatility, which might arguably make them leery of the crypto/blockchain space.
An early adopter
One of the first United States-based pension funds to invest in blockchain firms was the Fairfax County Police Officers Retirement System, based in Fairfax, Virginia. It tested the waters back in 2018 with an 0.5% allocation in a fund that was investing in blockchain-related enterprises, Katherine Molnar, the fund’s chief investment officer, said at the recent SALT conference in New York City.
In 2019, the fund increased its allocation to 1%, and in spring 2021, it added two new blockchain-related investment funds. The current target allocation is 2%, but due to the increasing value of crypto and crypto-based companies, 7 percent of total fund assets are now crypto-related — again, mostly “pick-and-shovel” type enterprises that support the industry, such as crypto exchanges and custodians.
The pension fund can’t rebalance because it is invested in venture capital funds, Molnar explained, but in mid-September, Fairfax signaled its intent to invest $50 million with Parataxis Capital, a crypto hedge fund that invests in digital tokens and cryptocurrency derivatives. “It’s not a directional bet, but it’s not totally illiquid either,” she said.
The fact that the police officers’ pension fund has invested until recently in crypto-related companies as opposed to cryptocurrencies — Coinbase rather than, say, Bitcoin (BTC) — isn’t uncommon, either. U.S. institutional investors surveyed by Fidelity Digital indicated a greater propensity for digital asset investment products rather than direct ownership of cryptocurrencies, Sandler told Cointelegraph, adding:
“From our study, we also know that pension funds and defined benefit plans, like many other institutional investor segments surveyed, favor active management of an investment product containing digital assets.”
More pension funds may now travel this road. “We’ve started to see participation not just from the hedge fund segment, which we’ve long seen participation from, but now it’s recently from other institutions, pensions and endowments,” Michael Sonnenshein, CEO of Grayscale Investments — the largest manager of digital assets — told Bloomberg earlier this year, adding he anticipated that pension funds and endowments would drive much of his investment firm’s future growth.
Even pension-fund giants like the California Public Employees Retirement System (CalPERS) have dipped a toe in the crypto/blockchain sea. CalPERS invested in Bitcoin mining firm Riot Blockchain LLC some years back and has since raised the stake to about 113,000 shares — worth about $3 million in early October — though that is minuscule compared with CalPERS’ $133.3 billion in equity assets under management, as of its 13F filing in August.
How much is enough?
What sort of crypto allocation is appropriate for a pension fund today? Jim Kyung-Soo Liew, assistant professor at Johns Hopkins University’s Carey Business School, co-authored one of the earliest academic papers on crypto and pension funds back in 2017. That paper found that a 1.3% Bitcoin allocation would be “optimal” to fully reap the cryptocurrency’s diversification benefit.
What is appropriate right now? “In the future, an institutional investor should be looking at a 10%–20% allocation,” Liew said, adding that he expects large pension funds to invest up to one-fifth of their total assets in the crypto/blockchain space within the next three to five years.
98% of retirement accounts in the US can’t access #Bitcoin.
What happens when they do?
— Dan Held (@danheld) October 7, 2021
“We’ll see more institutional investors,” Liew said, adding, “Their horizons are long.” Today’s $2 trillion in cryptocurrency market capitalization could swell to $20 trillion in the next three to five years, he added, assuming a favorable regulatory environment.
Asked if this doesn’t fly in the face of pension funds’ traditional conservatism, Liew answered, “Pension funds have boards; they have investment committees,” and yes, “they’re often accused of being overly conservative and wanting to understand things 100% before acting.”
From an education standpoint, it will take some time and effort to bring them along, but chief investment officers are quite intelligent as a group, and they will be able to grasp the concepts, Liew said. One problem, he allowed, “They’re not rewarded for risk-taking.”
There may be other impediments. “One challenge is that pensions tend to require large tickets,” McKeon said, “so the space had to mature a bit to accept that amount of capital. As funds continue to scale up, we expect to see more participation by pensions.” Volatility remains a concern, said Sandler, pointing to data:
“‘2021 Institutional Investor Digital Assets Study’ found that 73% of U.S. pension funds, defined benefit plans, and endowments and foundations surveyed cited volatility as the top barrier to adoption.”
U.S. pension funds and defined benefit plans still hold a fairly negative view of digital assets, according to the survey, “but I think we’ll continue to see that negative perception decrease as the market continues to mature and these investors get more comfortable with the technology, infrastructure and channels for exposure and have a more fully developed investment thesis about these assets,” she added.
As such, pension funds, like other institutional investors, are striving to find investment opportunities. As The New York Times noted, “U.S. Treasuries have been the bonds of choice for safe retirement income. But they could deliver no real return for the next decade.”
Meanwhile, on the positive side, pension funds have long horizons, and they can withstand short-term volatility. Another plus, “Crypto talent is spread uniformly around the world, and we can source that talent,” Liew added.
Fiduciary constraints won’t disappear, of course. Many pension funds represent municipalities, and they are holding many people’s late-life financial well-being in their hands. That’s a lot of responsibility. But you “can’t get a ton of reward if you don’t take on some risk,” Liew said.
“I understand the need to do this,” the president of Molnar’s board said a while back — the police officers’ pension fund, like most institutional investors, was struggling to grow its money in a low-interest-rate environment — but some officers “are off the reservation,” he claimed. With the fund’s recent 7.25 percent rate of return on crypto investments, it’s safe to assume that some of those officers are now back on the reservation.