In the first part of this blog post I talked about reasons why institutional investors could be hesitant about entering crypto markets. Today i would like to cover reason why they SHOULD enter the market and do it soon.
New asset class
Crypto securities are a totally new phenomenon in the financial markets. It’s a brand new asset class. Not sure what the last “invented” asset class was - may have been derivatives - but even those instruments are hundreds of years old. Critics of the cryptocurrency market often compare its behavior to that of the tulip markets in the 17th century Holland.
The tulip bubble popped when the traders of the futures contracts on the tulip bulbs got too greedy and out of hand with reality. Futures are a form of derivatives. So the last “new” asset class that I could think of is at least 400 years old. If you think there were others that were more recent - let me know in the comments.
New asset class provides new and exciting investment opportunities, new valuation techniques, new theoretical base for research and analysis. And of course, new risk and return horizons.
It’s all right if you didn’t know about cryptos prior to 2017, but unless you lived in a cave in 2017-2018, you couldn’t help, but notice crypto assets price dynamics. Cryptocurrency performance went mainstream in 2017. Everyone started talking about it. You heard the word “bitcoin” uttered in the streets by the cab drivers, burger flippers and hairdressers. Here's how the term "bitcoin" has been searched via Google over the last 1.5 years.
CNBC, Bloomberg and all the other media outlets went totally nuts, first about the skyrocketing performance of the new asset class and then about a similar market decline.
Institutional investors have a fiduciary duty before their investors to provide best investment options and to generate above benchmark returns. They also need to outperform their competition. Explaining to your investors why you haven’t invested in a new asset class (crypto) that generated triple-digit positive returns while your competitor did, is no fun and can lead to massive loss of business.
Here’s a chart showing growth of $100 invested on Jan 1, 2017 thru Jun 30, 2018 for BTC vs. S&P 500. If you are an institutional investor, you must be salivating over these returns.
It is a known fact that investing in crypto is a risky business. 20-30% daily swings in prices is a common scene for these tokens. Such volatility in the traditional assets can literally cause investors heart attacks. Investing in crypto is not for the faint of heart. However, as counter-intuitive as it may sound, adding to your portfolio a risky asset class like crypto can actually improve your portfolio’s overall risk-return characteristics. You can read all about it in the Markowitz’s Modern Portfolio Theory. But the point is that a portfolio manager can generate same amount of return in the same period, but with lower risk. This is huge.
Institutional Money is called “Smart Money” for a Reason
Institutional investors aren’t stupid. Quite the opposite. Wall St. has been notoriously hiring top talent from the best schools in the country and worldwide. To say that traditional finance guys don’t understand crypto would be a huge misstatement. They totally get it. News of prominent investment banks opening up their crypto trading desks pop here and there almost on a weekly basis. They are getting their ducks lined up in a row patiently waiting to join the race. And when they do, the impact on the market will be huge!