Wealth managers can adapt to digital assets and thrive
For many private wealth managers, investing in digital assets has been a step too far. Yet the recent news that the state of Virginia’s Fairfax County has invested two pension plans in Morgan Creek Asset Management, a digital asset manager with $1.4 billion under management, proves that an allocation to digital assets should be taken seriously.
The plans, the Employees Retirement System and the Police Officers Retirement System, have committed around $20 million in Morgan Creek’s new blockchain venture capital fund.
Accessing digital assets
It is an industry in its infancy. The market has been volatile and many of the products are unregulated: digital assets are undoubtedly higher risk than traditional mainstream investments. However, according to a recent report published by KPMG, there are over 2,000 digital assets with a total market capitalisation of more than $200 billion and there is a wide variety of digital investments on offer.
Although there is overlap between them and they are developing all the time, digital assets can loosely be divided into different silos: digital currency trading, digital asset exchange traded products (ETPs) direct equity investing using security tokens, blockchain-focused hedge funds and venture capital funds.
Investment in the asset class is done via digital asset exchanges. These exchanges began as virtual marketplaces specialising mainly in fiat to digital asset trading. In the last two years however, they have developed into state-of-the-art digital asset ecosystems. Their services encompass initial coin offerings (ICOs), security token offerings (STOs), ETPs, as well as access to blockchain venture capital start-up projects. What’s more, many exchanges are now laying the foundations for institutional-grade primary and secondary trading facilities which will comply with international regulations.
What happens when it is client-driven?
There are many in the wealth management industry that are sceptical. At present, digital assets are unfamiliar territory for everyone, and while global regulators are still at odds over regulation, managers are right to be cautious.
Nevertheless, they are starting to look at more practical ways of broadening out their investment portfolios to include digital assets. This is because often it is clients who are the driving force behind gaining exposure to digital assets.
The 2018 “World Wealth Report” by Capgemini found that nearly a third of respondents, all of whom were high net-worth individuals (HNWI), had a high degree of interest in digital assets. In particular, investors under 40 stated that were looking for more information from their wealth management firms on the asset class.
The report found that on a global basis, 29% of HNWIs showed a high degree of interest in digital assets. In interest the Asia-Pacific region was even higher with over 50%.
Adapt to digital assets and thrive
While the report states that HNWIs showed degrees of interest only, rather than active investing, wealth managers know that they must adapt to survive.
Institutional investors are actively investing in the asset class, whether it is in subsidiaries, custody or technology infrastructure. Last year, Fidelity launched its Digital Assets subsidiary and the Chicago Board of Exchange (Cboe) with SolidX and VanEck have applied for approval for a Bitcoin ETF. Similarly, the latest report published by Cambridge Associates, an investment advisory firm, recommends exploring investments in digital assets.
Furthermore, it is becoming apparent that most digital asset investors who have the majority of their net asset value in the space are looking for opportunities and advice on diversifying into more tangible and mainstream assets.
Wealth managers must seek out the advantages of this dynamic new market. Offering digital assets as an investable option will cater to the needs of modern investors and attract new capital from the digital asset millionaires. It will be their comprehensive knowledge, expertise and access to digital asset products that will ensure they remain competitive and their businesses will thrive.
Types of digital assets
- Digital asset trading
Similar to FX, digital asset trading involves the exchanging of either fiat to digital currencies or between digital currency pairs such as bitcoin or ethereum. It is possible to invest in newly launched coins (ICOs) and also in the increasingly popular STOs.
- Digital ETPs
Structured in a similar way to ETFs in that they track an index or basket of assets, a digital asset ETP generally tracks the top ten digital currencies. Their characteristics are similar to a leveraged ETP in that investors do not own the underlying assets. They differ from security token ETFs where investors have ownership of the tokens. In this case, the ETF trades in a similar way to a traditional equity-based ETF. While there is still no US regulatory approval for a digital ETF, it is possible to invest in a bitcoin ETF through for example, an exchange-traded note on Sweden’s Nasdaq Stockholm Exchange.
- Direct investing through security tokens
This is considered a less volatile way of investing in digital assets because security tokens are uncorrelated to the broader market movements. In addition, these are regulated entities which are traded in the same way as stocks or shares. However, there is less diversification as the investments are similar to venture capital projects such as blockchain, social impact and real estate. Therefore, there is a high risk of investments failing.
- Blockchain-focused hedge funds
These funds trade in established digital currencies, as well as invest in new ICOs and a range of service providers. They actively seek out volatility in order to maximise returns. Some hedge funds allocate only a small percentage of their investments into digital assets in order to lower risks.
- Blockchain-focused venture capital funds
Used as a form of fundraising, these funds are similar to early stage investments from a traditional venture capital firm. Many projects are direct investments covering blockchain, fine art, social impact and real estate projects. There is a high risk of failure and as a result, investors require a high level of expertise in the evaluation process. However, many traditional venture capital funds aiming to gain first mover advantage are moving into this space.
By Maxim Bederov
Maxim Bederov has nearly two decades of experience in financial services, most prominently at MLP Finanzdienstleistungen SE, a Germany-based consultancy for financial planning.
Bederov is now a serial entrepreneur and early-stage investor in a number of projects. He has been active in blockchain technology and the digital asset space since 2014. In 2018, he established one of the first retail funds incorporating digital assets.