If there is one type of investment that needs no marketing at the moment, it would probably be bitcoin. The cryptocurrency, one of the first of its kind, couldn’t get more airtime if it tried. And as with anything worth talking about, opinion is divided.
In recent weeks it has been dismissed as a fraud by JP Morgan chief Jamie Dimon but previously hailed as a great value play by fund manager Murray Stahl. Bitcoin’s price, which had been trading at $4,164, fell by 4% following Dimon’s comments.
As abstract as investing in bitcoin sounds, a Merrill Lynch fund manager survey in early September found that ‘long bitcoin’ was the most crowded trade out there. The finding is surprising for some investors, because even though bitcoin and its fellow cryptocurrencies have generated plenty of headlines, options for investing in bitcoin are still limited.
Securities and Exchange Commission rules mean that most funds can only buy securities. As a result, for a fund to invest in bitcoin, it has to purchase a vehicle such as the Bitcoin Investment Trust, rather than buying the cryptocurrency itself.
The Bitcoin Investment Trust is an open-ended grantor trust based in the US and sponsored by Grayscale Investments. The trust is invested exclusively in bitcoin and derives its value solely from the price of bitcoin, with the objective of having the trust’s net asset value per share track bitcoin's market price.
The trust is similar to an ETF in some respects. It is passively managed and aims to replicate bitcoin's movement. However, unlike an ETF it is not listed on a major exchange, and trades over the counter instead.
Within the bitcoin universe, mutual funds and exchange-traded funds (ETFs) that invest in instruments for the cryptocurrency are few and far between. According to Morningstar, just 19 US-domiciled funds have invested in the Bitcoin Investment Trust. Of those 19 funds, nine are strategies offered by New York-based Horizon Kinetics and run by Stahl.
In addition to Stahl’s funds or buying into the Bitcoin Investment Trust, investors looking to access the cryptocurrency can do two things: buy bitcoin directly by opening an account – commonly referred to as a wallet – or buy it on a ‘bitcoin exchange’ such as Coinbase.
Although all these channels seem fairly straightforward, they are not for the faint-hearted, given all the complexities and risks of dealing with the combination of a disruptive new technology and a hard-to-value currency.
Paul Courtney, director of research at SpringTide Partners, has found a massive gap between the philosophical underpinnings of those who like cryptocurrencies and those who don’t.
‘It’s unknowable what the value of these assets will be in the future. People who believe in them believe not because they‘ve done a discounted cash flow and think that the current price is left on a fair value base,’ he said. ‘They believe in bitcoin because of their belief in what the future is going to look like, so you have to be very sensitive to what these opinions mean.’
While Courtney admits there is plenty of information available about bitcoin, he says the changing nature of the currency and its ecosystem make it very risky.
‘We only have an opinion if people approach us first, it is not something we are pitching to clients,’ he said. ‘We would either advise to do it directly or to do it through a professional manager who’s familiar with the space and manages a diversified portfolio of the most useful supply-constrained digital assets.’
When attempting to perform due diligence on cryptocurrencies such as bitcoin, Courtney approaches it as he would a call option, in that the investment needs to be sized relative to the risk that investors are taking. He said that although call options are useful and sometimes rewarding instruments, the majority of call options that investors buy are heading to zero.
‘Think of it almost as reverse insurance, so you are buying a contract hoping that a specific event happens. If it happens, you will make a lot of money. If it doesn’t happen then you lose all your money. We think that is a good analogue to cryptocurrency and that is why I want people to invest in cryptocurrency only if they are comfortable with the idea that they could go to zero,’ he said.
For investors wanting to buy into bitcoin, Courtney recommends they only put a very small portion of their wealth into a diversified basket of digital assets.
While the vast majority of gatekeepers, asset managers and investors agree that bitcoin represents extreme risk and volatility, it has not stopped some from taking a position.
Mike Venuto, co-founder and chief investment officer of New York-based RIA Toroso Investments, is one. ‘We took an extremely small position in bitcoin because we looked at it and said based on the thesis, this could be something that returns 400% or 500%,’ Venuto said. ‘The worst case scenario is that we are going to lose 1% [of our portfolios].’
He added that he sees parallels between bitcoin and gold in terms of inflationary and diversification benefits.
However, Venuto also wanted to be clear that he is not a cheerleader for bitcoin and said that investors thinking of buying the cryptocurrency should be well diversified. ‘I believe it's worth somewhere between zero and $50,000 apiece and it's not really in the middle. [Bitcoins] are either what Jamie Dimon claims they are, or they change the world,’ he added. ‘And something that has that much risk/reward to it, it's not about taking a bet – it's about sizing the position and considering these outcomes versus the other things in your portfolio.’
Shaking things up
Compared with the hundreds of other cryptocurrencies out there, Venuto still thinks that bitcoin is the most interesting because it is open source.
‘Think of bitcoin as the first operating systems and everybody can work within it,’ he said. ‘Companies build themselves around the ways to utilize these operating systems. Ethereum is like Apple, which has a closed network controlled by a consortium of people.’
Brett Rentmeester, president and chief investment officer at WindRock Wealth Management, said that the current debate surrounding bitcoin was reminiscent of the internet stocks era, when real players and fraudsters co-existed and investors had to be very careful with how they sized and diversified their investments.
‘This is a similar era. This is a very disruptive technology with a lot of potential but it’s in the very early innings of where we are headed,’ he said.
‘What's unique about the space is that on the one hand, it's a play similar to the internet – a new technology that is disruptive to the global economy,’ Rentmeester said.
‘On the other hand, it's a little bit of a hedge against the current currency system in the world. As the world continues spending more than it makes, taking on debt, printing money and covering the gaps, cryptocurrency might be the way to hedge against that risk.’
As many investors debate the merits of cryptocurrencies, some simply cannot foresee them being in their portfolio.
‘I don't see bitcoin going away, but I don’t see it being adopted soon either. It would create too much volatility in a client's portfolio, too many unanswered questions,’ said Patrick St. Denis, director of investments at Spouting Rock.
‘But there is certainly a level of FOMO [fear of missing out] involved when looking at the price going up and down.’