APG’s chief economist Thijs Knaap and senior strategist Charles Kalshoven lay out the case for not investing in crypto. Interrogating the investment case for cryptos they find that only an expected return of 25 per cent per year would make it worthwhile to add bitcoins to the portfolio, and even then there’s no cashflows. They argue that pension funds can afford to neglect this asset class.
Despite the recent heavy losses crypto investors have suffered and the crash of stablecoin, whose primary claim was that it could never crash, the returns are still impressive.
Take bitcoin for example, the oldest of around 18,000 cryptocurrencies that exist today. Trading at a little over €2,000 ($2,041) five years ago, today a bitcoin is worth around €20,000 (down from a high of almost €60,000 at the end of 2021). Among those million-plus crypto investors, there are undoubtedly some whose pension is being managed by APG. And if they are willing to invest their own money, shouldn’t their pension fund jump in too?
In July 2021, Germany’s financial regulator BaFin allowed just that when it enacted new regulations that say institutional investors can allocate up to 20 per cent of their assets to cryptocurrencies. As the FT wrote at the time, this was an attempt by BaFin ‘to balance its concerns about what is has 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 biggest asset manager, launched its iShares Blockchain and Tech ETF that ‘seeks to track the investment results of an index composed of US and non-US companies that are involved in the development, innovation, and utilisation of blockchain and crypto technologies.’
In an accompanying report, BlackRock is bullish: ‘While most of the market attention has focused on the price and volatility of cryptocurrencies themselves, we believe the broader opportunity – leveraging blockchain technology for payments, contracts and consumption broadly – has not yet been priced in.’
Is crypto investing appropriate for APG?
With retail and institutional investors alike flocking to cryptocurrencies, and regulators holding open the doors, should APG not follow suit? That’s a legitimate question.
“We’re regularly being asked why we’re not investing in cryptos, by media and by people on Twitter who point out that our coverage ratio would look a lot better if only we had been smart enough to invest in cryptos early. Look past the recent losses and crashes, and surely cryptos will increase in value again some day and new and improved currencies will be launched?”
But APG is not going to invest anytime soon.
The view outlined by Knaap and Kalshoven is that pension funds, even more so than other long-term investors, need to invest in assets that generate cash flows: stocks that pay dividends, bonds that pay interest, real estate for which rent payments are received. The basic idea is that every month about as much cash needs to flow in as APG pays out to pensioners.
“A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate any cash. The only way to make a return on cryptos is to sell them to the next investor who is willing to pay more than you did. In the meantime nothing happens, to us that makes investing in cryptos unattractive as well as unpractical,” the authors say.
A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate any cash
Pension funds do invest in other assets without cash flows, like commodities and gold. But apart from their inherent value, these assets have other appealing characteristics.
“We know, based on data that sometimes goes back hundreds of years, how they correlate with other asset classes or economic parameters. Gold for example moves along with the general price level and thus provides a good hedge against inflation. Bitcoin doesn’t have a 200-year history, and neither 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: crypto currencies provide no cash flows and no hedges. From a technical investment perspective we therefore don’t see a reason to invest in them.”
Applying 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 and return ratio and study what happens when you add bitcoins to such a portfolio. Assumptions about correlations and volatility aside, the outcome was very clear: only with an expected return of 25 per cent per year would it be worthwhile to add bitcoins to the portfolio. With a horizon of 15 years, you have to ask if there is anything that justifies a growth of 25 per cent year on year for such a period. The answer is no, there is simply no way we can justify that. So along that line of thought you come to the same conclusion: the investment case for cryptocurrencies just isn’t there.”
If the board did decide to invest in crypto, investment staff would then be asked to develop a formal investment case and extensively document aspects such as expected returns, risk, liquidity, correlations and so on. ESG would also be taken into account.
To this end they say that the bona fides of counterparties would be a concern, as well as the fact that the mining of cryptocurrencies requires an inordinate amount of energy.
“A pension fund that has banned investments in fossil energy would have a hard time letting that pass. Then there are regulators that don’t have a favorable view of cryptocurrencies, and finally it would operationally be very challenging for us and different from how we manage our other assets. So apart from the lack of an investment rationale, there is also a host of practical reasons why APG won’t be investing directly in cryptocurrencies in the foreseeable future.”
Comparisons with other disruptors
The essential difference between early internet pioneers like Google and other search engines and bitcoins, the authors say, is that for search engines you could, even early on, imagine a viable business model that monetized advertising and services.
“For bitcoins really the only thing that allows you to make money is the greater fool approach to investing: find someone who is willing to pay more for them than you did. There’s just 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 look carefully at any reasons that will drive their future value up. Acknowledging the basic premise of cryptos – that they cut players loose from the traditional financial sector that is slow, expensive and over-regulated – makes them attractive. Cryptocurrencies enable you to make transactions completely autonomously and with anyone anywhere, as long as they have a computer or a smart phone.
It’s like this nightclub that’s so great because only cool people go there. The moment we enter that club is the moment it stops being great and cool
“The main application for bitcoin so far seems to be the payment of ransom money to some Russian who has encrypted your hard disc. That shows you the basic idea works fine. You don’t have to bother with Know Your Customer or money laundering controls,” they say. “Pension funds however simply can’t be buying bitcoins from someone who may have earned them in some illegal manner, so they bring their whole regulatory apparatus with them. That will cause a strange dynamic to come into play once cryptos become so big and successful that traditional financial institutions have no choice but to get involved.
“When that happens, it will be the kiss of death. Cryptos will become wrapped in the traditional world of finance, which means the very aspect that made them attractive will disappear. It’s like this night club that’s so great because only cool people go there. The moment we enter that club is the moment it stops being great and cool. So there is trade-off: cryptos can either remain entirely separate from traditional finance and find little adoption, or they can embrace elements of traditional finance and lose some of their appeal.”
