Client Portfolios & Crypto

Advisors are working to define the role of a brand new asset in client portfolios.

Reviewed by: Debbie Carlson
Edited by: Debbie Carlson

Cryptocurrencies have sat mostly on the sidelines of traditional investing for several years, but many financial advisors are cautiously considering a role for digital assets in portfolios as client interest increases.

Digital coins may be a new asset class, but how advisors judge suitability for their clients in broader asset allocation hasn’t changed. The basics still stand: Advisors need to understand a client’s risk tolerance, time horizon and goals to determine if cryptos are a good diversifier.

Advisors who want to add cryptocurrencies should keep the allocation as an extremely small part of a total portfolio—no more than 1-3%—and have it be part of a satellite position.

Don’t Dismiss Crypto
Some advisors who automatically veto cryptocurrencies without researching the asset are making a mistake, says Eric Ervin, CEO of Blockforce Capital, a cryptocurrency asset management firm, and co-founder of Onramp Invest, a technology platform allowing registered investment advisors access to cryptocurrencies.

“It’s easy to say ‘it’s not suitable’… which is making a fiduciary decision for the client without necessarily looking at it,” he said.

Clients may push back, and if advisors have no data or tools to justify their decision, the worst-case scenario is the client moves on and tries a DIY approach, Ervin adds.

“The worst thing that could happen is the client leaves, takes all of their money with them, puts it all in crypto assets and it blows up,” he said.

Sizing Up Suitability
WE Family Offices advises its ultra high net worth clients on cryptocurrencies, explains Matt Farrell, senior investment manager at the firm. It offers that exposure three ways: owning actual cryptocurrencies such as bitcoin and ethereum; through private market investments into the blockchain infrastructure; and through hedge-fund-type vehicles to capture the inherent volatility in digital assets.

The firm takes a long-term view on cryptocurrencies, wanting to hold them for several years or more and stressing this to clients as part of detailed educational sessions so clients know exactly what they’re getting into.

“We advise clients to come in with their eyes wide open; that they should expect volatility and drawdowns, and therefore, we size appropriately,” he said.

That means keeping holdings to about 1% of total assets under management in coins or through hedge funds, and then complementing the position with private investments focused on infrastructure.

Ervin uses a rule of three: holding assets for at least three years; limit holdings to 3% to avoid making an outsized call; and for those investing regularly, allocate no more than 3% of discretionary income to the space.

Portfolio Introduction
Many advisors aren’t proactively offering cryptocurrencies because of the volatility, but are talking with clients when they bring it up. A lot of it is educational.

Brian Jass, advisor at Great Waters Financial, says that one client called him with worries about stock market volatility. “He said, ‘I want to buy bitcoin because it’s safe,’” Jass explained, which prompted further discussion about the client’s intent.

Meghan Railey, co-founder and chief financial officer of Optas Capital, says that when clients ask about investing in crypto, she frames conversations to reflect the volatility, saying it’s more gambling than investing: “This is how we think about asset classes that can fluctuate so dramatically on a daily basis. We think it’s still highly speculative at this point.”

If clients still want to invest in cryptos, Railey directs these individuals to buy stablecoins—cryptocurrencies that attempt to use an external reference as a peg—and to buy them on a trusted exchange. The stablecoin category includes cryptocurrencies like TrueUSD and USD Tether. Railey also warns clients to be prepared that the money invested could go to zero.

Regular Check-ins
Both Jass and Railey have clients who control their own cryptocurrency accounts, and the advisors will ask about those positions during regular check-in meetings. Jass says even though he isn’t monitoring the positions, he wants to be informed, saying the last thing he wants is for a client to feel embarrassed or be secretive about it.

Some of Railey’s clients have large investments in coins because they were involved in the space early on, and for those clients whose positions require monitoring, her firm can custody those at Fidelity or Coinbase.

It’s critical to find a manager who can custody the coins in a cold storage location—that’s storing coins offline—to reduce hacking risks, Farrell stresses: “You sacrifice a little bit of liquidity, but what you gain is reduced operational risk.”

For clients with significant positions, Railey “highly recommends” regular rebalancing, because cryptos’ value fluctuates so much. The downside is tax inefficiency and potentially missing out on long-term gains. But it can help in avoiding bad decisions based on emotion, she notes.

“People could lose confidence in the stability of crypto in a second, so we want to be constantly making sure we’re keeping aligned with our target allocation, whatever the policy we come up with for the allocation,” Railey said.

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Different Cryptos
Alex Tapscott, managing director of digital asset group for the Toronto-based Ninepoint Partners, acknowledges that every client’s portfolio needs and asset allocation are different, yet “there are a lot of very compelling reasons for investors to consider owning crypto assets, specifically bitcoin.”

Tapscott believes bitcoin matured into an institutional-grade investment, with now trillions of dollars invested in it. He says that bitcoin offers diversification, complementing the role gold and other precious metals play in a portfolio. Similar to gold, bitcoin has a low correlation to other assets, it’s not controlled by governments, there’s finite supply and it can be used for payments.

He notes bitcoin has some benefits that gold doesn’t, particularly that storage is more convenient and it’s easier to divide into smaller increments: “I think we’ve reached the end of what gold can do.”

Tapscott points out that bitcoin can contribute better risk-adjusted returns because of its low correlation to other asset classes, which makes his firm comfortable recommending that investors consider the cryptocurrency.

“Do you want to bet the farm on any single asset, let’s say, shares of a company or bitcoin? No, of course not,” he said. “You consider the benefits of diversification of improving your overall risk-adjusted return.”

Ethereum is the other cryptocurrency some in the alt-currency world consider suitable for portfolios. Both Tapscott and Ervin agree that while bitcoin is like digital gold, Ethereum is akin to making a bet on a high-growth company because of the way companies are using Ethereum as a technology platform to build businesses. Ethereum is essentially a blockchain-based network designed to support decentralized applications.

Other Ways To Invest
As of early September, true cryptocurrency ETFs were only available outside the U.S. Gary Gensler, chair of the SEC, strongly hinted that the commission may approve a futures-based bitcoin ETF, leading to waves of filings for such a cryptocurrency ETF in the wake of his statement.

Index providers are creating ways for ETF issuers to access the asset class. In late August, Alerian created two crypto and blockchain indexes, the Alerian Galaxy Global Blockchain Indexes and Alerian Galaxy Global Cryptocurrency-Focused Blockchain Indexes, covering several types of industries in the space.

For advisors who aren’t ready to invest in coins themselves and want the ease of an ETF, blockchain ETFs are an option, such as the Amplify Transformational Data Sharing ETF (BLOK).

“You’re not going to necessarily have the upside [you’d get with cryptocurrencies] … but you’re going to have meaningful upside, probably outperforming the S&P 500 or even a general technology ETF,” Ervin said.

Debbie Carlson focuses on investing and the advisor space for U.S. News. She is an internationally published journalist with bylines in publications including Barron's, Chicago Tribune, The Guardian, Financial Advisor, ETF Report, MarketWatch, Reuters, The Wall Street Journal and others.