APG Chief Economist Thijs Knaap and Senior Strategist Charles Kalshoven discuss why crypto should not be invested. By querying the investment case for cryptos, they find that only an expected return of 25% per year would justify adding bitcoins to the portfolio, and even then there is no cash flow. They argue that pension funds can afford to neglect this asset class.
Despite the recent heavy losses suffered by crypto investors and the crash of the stablecoin, the main assertion of which was that it could never collapse, the returns are still impressive.
Take bitcoin for example, the oldest of the approximately 18,000 cryptocurrencies in existence today. Trading at just over €2,000 ($2,041) five years ago, a bitcoin is now worth around €20,000 (down from a high of nearly €60,000 in late 2021). Among these more than one million crypto investors, there are undoubtedly some whose pension is managed by APG. And if they are willing to invest their own money, shouldn’t their pension fund also step in?
In July 2021, German financial regulator BaFin allowed this when it enacted new regulations which state that institutional investors can allocate up to 20% of their assets to cryptocurrencies. As the FT wrote at the time, it was an attempt by BaFin “to balance its concerns about what it described as the ‘highly risky and speculative’ nature of cryptocurrencies with its desire to encourage the development of new technologies that could have a significant effect on financial services”.
More recently, BlackRock, the world’s largest asset manager, launched its iShares Blockchain and Tech ETF which “seeks to track the investment results of an index comprised of US and non-US companies involved in the development, innovation and the use of blockchain”. and cryptographic technologies.
In an accompanying report, BlackRock is bullish“While most of the market’s attention has focused on the price and volatility of cryptocurrencies themselves, we believe the broader opportunity – leveraging blockchain technology for payments, contracts and consumption in the broad sense – has not yet been taken into account.”
Is crypto investing suitable for APG?
As retail and institutional investors flock to cryptocurrencies and regulators keep the doors open, shouldn’t APG follow suit? It’s a legitimate question.
“We are regularly asked why we are not investing in cryptos, by the media and by people on Twitter who point out that our coverage rate would be much better if only we had been smart enough to invest in cryptos early. Look past the recent losses and crashes, and surely cryptos will one day rise again and new and improved currencies will be launched? »
But APG is not going to invest any time soon.
The view put forward by Knaap and Kalshoven is that pension funds, even more than other long-term investors, should invest in assets that generate cash flow: stocks that pay dividends, bonds that pay interest, real estate for which rental payments are collected. The basic idea is that each month approximately as much cash should be paid out as the APG pays out to retirees.
“A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate cash. The only way to make cryptos profitable is to sell them to the next investor who is willing to pay more than you. meanwhile, nothing happens, for us this makes investing in cryptos unattractive and impractical,” the authors state.
A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate cash.
Pension funds invest in other assets with no cash flow, such as commodities and gold. But besides their intrinsic value, these assets have other attractive characteristics.
“We know, based on data that sometimes goes back hundreds of years, how it correlates with other asset classes or economic parameters. Gold, for example, follows the general price level and is therefore a good hedge against inflation. Bitcoin does not have a 200 year history nor does it have a strong correlation with other assets. Well, lately maybe with stocks, but that provides no diversification to our portfolio and no hedge against anything. So in short: cryptocurrencies provide no cash flow and no hedging. From a technical investing point of view, therefore, we see no reason to invest in it.
Application of portfolio theory
The authors say that arguments from portfolio theory can also be applied.
“You can take a well-diversified portfolio with a certain risk/reward ratio and study what happens when you add bitcoins to such a portfolio. Correlation and volatility assumptions aside, the result was very clear: only with an expected return of 25% per year would it be worth adding bitcoins to the portfolio. With a 15-year horizon, one has to wonder if there is anything that justifies 25% year-over-year growth for such a period. The answer is no, there is simply no way to justify this. So in that line of thinking, you come to the same conclusion: the investment case for cryptocurrencies just isn’t there. »
Should the board decide to invest in crypto, investment staff would then be asked to develop a formal investment case and document in detail aspects such as expected returns, risk, liquidity, correlations, etc. ESG would also be taken into account.
To that end, they say the good faith of counterparties would be a concern, as well as the fact that mining cryptocurrencies requires an inordinate amount of energy.
“A pension fund that has banned fossil fuel investments would be hard pressed to let this pass. Then there are regulators who don’t have a favorable view of cryptocurrencies, and finally, it would be very difficult for us operationally and different from how we manage our other assets. So, aside from the lack of investment justification, there are also a host of practical reasons why APG will not invest directly in cryptocurrencies for the foreseeable future.
Comparisons with other disruptors
According to the authors, the key difference between early Internet pioneers like Google and other search engines and bitcoins is that for search engines, you could, even very early on, imagine a viable business model that monetized advertising and Services.
“For bitcoins, the only thing that really lets you make money is the dumbest approach to investing: find someone who’s willing to pay more for them than you did. There’s nothing else that would make them worth more.
But while APG doesn’t see the investment case for cryptos now, they said they will continue to carefully consider any reasons that will increase their future value. Recognizing the basic tenet of cryptos – that they cut players off from the traditional financial sector which is slow, expensive and over-regulated – makes them attractive. Cryptocurrencies allow you to carry out transactions completely independently and with anyone, anywhere, as long as they have a computer or smartphone.
It’s like that nightclub that’s so great because only cool people go there. The moment we walk into this club is the moment it stops being awesome and cool
“So far, bitcoin’s main application seems to be paying a ransom to a Russian who encrypted your hard drive. This shows you that the basic idea works well. You don’t have to worry about knowing your customer or controlling money laundering,” they say. “However, pension funds simply cannot buy bitcoins from someone who may have earned them illegally, so they bring their entire regulatory apparatus with them. This will cause some strange dynamics to come into play once cryptos become so big and successful that traditional financial institutions will have no choice but to get involved.
“When that happens, it will be the kiss of death. Cryptos will be shrouded in the traditional world of finance, which means the very aspect that made them attractive will disappear. It’s like that nightclub that’s so awesome because only cool people go in. The moment we enter this club is when it stops being awesome and cool, so there is a trade-off: cryptos can either remain entirely separate from traditional finance and find little adoption, or they may adopt elements of traditional finance and lose some of their appeal.