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Why Financial Advisers Are Wary of Cryptocurrency

Advisers are weighing volatility risk and the value proposition of cryptocurrencies before adding them to client portfolios.

It’s not quite a thing yet. It might be soon given all the buzz. Someday soon it might become an asset class that investment advisers use in their client’s portfolios -- right alongside other alternative investments.

But at the moment, most of the advisers interviewed for this article don’t plan to add cryptocurrencies such as bitcoin, ethereum, and litecoin to their client’s portfolios anytime soon.

“I am not currently recommending adding to crypto,” said Thom Rindahl, a certified financial planner with TruWest Wealth Management Services. “I do see the benefits of it as a commodity like other commodities, but I do have my concerns regarding it such as government regulation and the concept of limited supply.”

Read: Bitcoin Is a Hedge Against Inflation - Or Is It?

Others are in the same camp. “I have not -- and do not plan to -- add cryptocurrency to my clients’ portfolios,” said Nicole Gopoian Wirick, president of Prosperity Wealth Strategies. “When it comes to something as important as your money, I believe there is great wisdom in being boring. That’s why I invest in globally diversified, multi-asset class portfolios that are aligned with your risk targets and goals.”

Cryptocurrencies, said Gopoian Wirick, are not part of that value proposition and they introduce too much volatility into the portfolio, especially given that bitcoin experienced three crashes exceeding 85% since 2010. “Although it has recovered from those three crashes, most investors simply cannot tolerate an 85% loss,” she said. “Downside volatility coupled with withdrawals can decimate a portfolio.”

Michelle Buonincontri, a certified financial planner, also never uses, as a general rule, something she doesn’t understand, cryptocurrency being one of them.

Meanwhile, others -- driven in large part by questions from clients -- are trying to learn as much as they can about cryptocurrencies and are considering cryptocurrency as an asset class.

For instance, Eric Walters, the managing partner of Summit Hill Wealth Management, is investigating whether cryptocurrency should be an asset class to add to his clients’ portfolios. According to Walters, an asset class should have a few characteristics:

  • A definition of the asset: What qualifies and doesn't qualify?
  • The purpose of holding the asset: What return is the investor seeking?
  • A historical pattern of returns to understand risk and returns: How has it performed? What is the standard deviation and correlation with other assets? What are the drivers of the returns? How will it contribute to risk-adjusted returns?
  • Is there a rational way to value the asset? Is there a way to know what projected returns are based on current valuations?
  • A reliable way to access the asset: How can it be held? What are the fees? Who are the custodians and investment managers? What protections are in place for investors? How would you sell it?

To be sure, there are other factors. But when Walters applies these questions to cryptocurrency, he gets mixed but interesting results:

Definition: “It seems that cryptocurrencies are easily identified but which ones are the real deal versus fakes?” Walters asked. “Do you invest in all of them or just some? What about blockchain technologies and companies? It is still the ‘early days’ but an adviser will need to answer these questions.

Purpose: “I think many crypto investors are focused on momentum,” said Walters. “I think that’s a poor rationale for investing in something. I'm not sure about the thesis for holding cryptocurrencies. One could argue that fiat-based currencies are being devalued and cryptocurrencies offer a market-based alternative. I'm open to that idea but there are so many cryptocurrencies that there may be too much supply. And does anyone really think the U.S. dollar is less trustworthy than a cryptocurrency? I think that is laughable. However, investing in the top cryptocurrencies and blockchain technology could allow you to invest in a new technology that could streamline existing transactions and payments. That's an economic and real-world problem and solution I could get behind as an investment.”

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Historical returns: “There are now multiple years of price returns that show extreme volatility,” said Walter. “Personally, I like to see 30-40 years of returns before making an investment. I haven't seen the data, but I think the standard deviation would be astronomical. I think you could view cryptocurrencies as something of an early-stage venture capital investment. Most will fail but some may do very well.”

Valuation: “I have no idea on how to value this,” said Walters. “Bitcoin has a limited supply but I'm not sure that really matters if nobody wants to use it. Again, if this is like a venture stage investment valuation isn't as relevant. You just want to make sure you're not jumping into a bubble. Bitcoin seems like a bubble to me now -- just pure momentum and enthusiasm.”

Access: “We've seen a major change with BNY Mellon and Fidelity agreeing to custody crypto assets,” said Walters. “Multiple mutual and ETF funds are springing up to access the space. It seems like access and custody questions are being answered.”

Related: MicroStrategy Wavers After Purchase of 262 Bitcoins for $15M

So, what’s the takeaway for Walters? “Cryptocurrencies and blockchain assets are worth a careful look by advisers at this point,” he said. “There is a definable asset class developing that may solve real-world problems. There are some historical returns that give us an idea of how they might perform.”

And, according to Walters, if advisers view it similar to a venture investment, they:

  • Would access cryptos in a broad way, to allow us to catch future winners that are unknown -- along with blockchain companies.
  • Wouldn't worry about valuation because it's an emerging asset class that could disappear. “If it is successful, the future gains could be enormous,” he said. “If it fails, the losses would also be enormous.”
  • Would access it with reputable partners to allow for reliable transactions, record keeping, and exits
  • Limit the exposure in client portfolios. “Remember, this entire class of investments could disappear or fail,” he said. “Personally, I would allocate 3-7% of a portfolio to venture-style investments that are broadly diversified. I'd have careful conversations with clients before investing to make sure they understood the risks and unknowns and update their records or investment policy statements to reflect this.”
  • Consider waiting to add exposure until the broader market dips or enthusiasm for the space wanes. March 2020 would have been a great time to do this.

More: Bitcoin Is Now an Asset Class - So What's the Next Bitcoin?

To be fair, Walters is among a small but growing number of advisers who are giving careful thought to the notion of cryptocurrencies as an asset class to add to a client’s portfolio, including retirement-focused portfolios.

And, organizations, such as the RIA Digital Assets Council have sprung up to “give financial advisers the knowledge and skills they need to provide their clients accurate, relevant, timely and valuable advice about blockchain and digital assets.”

Plus, major players in the financial services industry are going all in on digital assets. Citing strong client demand, the nation's largest custody bank, BNY Mellon, is building infrastructure and a team that can help clients store and manage bitcoin and many other types of virtual currency and tokenized assets, according to a FinancialPlanning report.

Yes, many advisers still think there are better ways to invest in the digital asset space than by investing directly in cryptocurrencies. “I would say investing in the ancillary areas that support crypto makes more sense and has a greater broader application than a pure commodity price play,” said Rindahl.

But the digital asset train, though it’s still in the station, is moving.

“With companies like Square  (SQ) - Get Block Inc Class A Report and Tesla  (TSLA) - Get Tesla Inc Report making big public purchases it sure seems like an asset class that is interesting, Charlie Munger’s verbiage notwithstanding,” said one adviser.