• Crypto and pension funds: a match made in heaven, or perhaps not?

  • 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 favor, 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 many pensions now have exposure to crypto,” said Stephen McKeon, a finance professor at the University of Oregon and a partner at Collab+Currency.

    “We’ve seen increased interest from pensions” in the last year, according to Christine Sandler, head of sales, marketing, and research at Fidelity Digital Assets, “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.”

    According to Sandler, pension funds are “more conservative, risk-averse investors relative to other segments,” and they prefer investments with long-term growth and low volatility, which may make them wary of the crypto/blockchain space.

    A trailblazer

    The Fairfax County Police Officers Retirement System, based in Fairfax, Virginia, was one of the first pension funds in the United States to invest in blockchain firms. Katherine Molnar, the fund’s chief investment officer, told ULTCOIN365 at the recent SALT conference in New York City that it tested the waters in 2018 with a 0.5 percent allocation in a fund that was investing in blockchain-related enterprises.

    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 cannot rebalance because it is invested in venture capital funds, according to Molnar, but Fairfax announced its intention to invest $50 million in Parataxis Capital, a crypto hedge fund that invests in digital tokens and cryptocurrency derivatives, in mid-September. “It’s not a directional bet, but it’s also not completely illiquid,” she explained to ULTCOIN365.

    It’s also not uncommon for the police officers’ pension fund to have invested in crypto-related companies rather than cryptocurrencies — Coinbase rather than, say, Bitcoin (BTC) — until recently. Sandler told ULTCOIN365 that U.S. institutional investors polled by Fidelity Digital preferred digital asset investment products over direct ownership of cryptocurrencies.

    “We also know from our research that pension funds and defined benefit plans, like many other institutional investor segments surveyed, prefer active management of an investment product containing digital assets.”

    This path may now be taken by more pension funds. “We’ve started to see participation not just from the hedge fund segment, which we’ve long seen participation from, but now we’ve recently seen participation from other institutions, pensions and endowments,” Michael Sonnenshein, CEO of Grayscale Investments — the largest manager of digital assets — told Bloomberg earlier this year, adding that pension funds and endowments would drive much of his investment firm’s future growth.

    Even pension fund behemoths like the California Public Employees Retirement System (CalPERS) have dabbled in the crypto/blockchain waters. CalPERS invested in Bitcoin mining firm Riot Blockchain LLC several years ago and has since increased its stake to approximately 113,000 shares — worth approximately $3 million in early October — though this is insignificant when compared to CalPERS’ $133.3 billion in equity assets under management as of its 13F filing in August.

    How much is too much?

    What kind of cryptocurrency allocation is suitable for a pension fund today? In 2017, Jim Kyung-Soo Liew, an associate professor at Johns Hopkins University’s Carey Business School, co-authored one of the first academic papers on crypto and pension funds. According to the findings of that paper, a 1.3 percent Bitcoin allocation would be “optimal” for fully reaping the cryptocurrency’s diversification benefit.

    What is appropriate right now? “Going forward, an institutional investor should be looking at a 10%–20% allocation,” Liew told ULTCOIN365, 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.

    “We’ll see more institutional investors,” Liew predicted, adding that “their horizons are long.” Today’s $2 trillion in cryptocurrency market capitalization, he predicted, could rise to $20 trillion in the next three to five years, assuming a favorable regulatory environment.

    When asked if this doesn’t go against the traditional conservatism of pension funds, Liew responded, “Pension funds have boards; they have investment committees,” and yes, “they’re often accused of being overly conservative and wanting to understand things 100 percent before acting.”

    It will take some time and effort to bring them along in terms of education, but chief investment officers are quite intelligent as a group and will be able to grasp the concepts, according to Liew. “They’re not rewarded for risk-taking,” he admitted.

    Obstacles still exist.

    Other impediments could exist. “One challenge is that pensions typically require large tickets,” McKeon explained to ULTCOIN365, “so the space had to mature a bit to accept that amount of capital.” As funds grow in size, we expect to see more participation from pension funds.” According to Sandler, volatility remains a concern, as evidenced by the following data:

    “According to the ‘2021 Institutional Investor Digital Assets Study,’ volatility was cited as the top barrier to adoption by 73 percent of U.S. pension funds, defined benefit plans, endowments, and foundations surveyed.”

    According to the survey, U.S. pension funds and defined benefit plans still have a fairly negative perception of digital assets, “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 a result, pension funds, like other institutional investors, are on the lookout for new investment opportunities. “U.S. Treasuries have been the bonds of choice for safe retirement income,” according to The New York Times. However, they are unlikely to provide a meaningful return over the next decade.”

    On the plus side, pension funds have long time horizons and can withstand short-term volatility. Another advantage is that “crypto talent is distributed uniformly around the world, and we can source that talent,” Liew explained.

    Of course, fiduciary obligations will not go away. Many pension funds represent municipalities, and they are responsible for many people’s late-life financial well-being. That’s a lot of weight on your shoulders. However, “you can’t get a lot of reward if you don’t take some risk,” according to Liew.

    “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.

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