Though some of the world’s ultra-wealthy have been snapping up cryptocurrencies for the past few years, 2021 is the year when digital currencies finally moved into the mainstream. What was a fringe investment vehicle has now been taken up by financial institutions, with a couple of Canada’s bitcoin ETFs, such as those of 3iQ and Purpose, each hitting about $1 billion in assets under management about a month after launch.
The rush of Canadian investment dollars into digital currencies both directly, through digital wallets, and indirectly through ETFs and mutual funds, has many financial advisors wondering how they can stake out some ground for their clients in this rapidly evolving landscape. With many wealth managers still in education mode with many of even their wealthier, more sophisticated investors, where do digital currencies fit in client portfolios, and how are financial advisors refining their portfolio management approaches to incorporate cryptocurrencies? We checked in with three experts for their take.
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Cryptocurrencies present valuation and execution challenges for advisors and clients alike, comments Jason Pereira, partner and senior financial consultant at Woodgate Financial Inc. in Toronto.
“Cryptocurrencies were created as an alternative currency, but virtually no one is buying and holding them for that purpose. Instead, Bitcoin, Ethereum and their digital currency peers are being sought out as investments, although there’s no consensus, whether academic or otherwise, about how they fit into a client’s portfolio.”
Periera says there are two main schools of thought about how to accommodate cryptocurrencies in client holdings.
The first is to treat them “like a form of so-called ‘digital gold,’” he says, adding that not all of the reasons to hold gold in a portfolio apply to cryptocurrencies. While gold is typically understood as a store of value, a liquidity hedge, and as an asset that can accumulate value in the right market conditions, there’s no agreement that digital currencies provide a store of value – and the 2017 Bitcoin boom, followed by the 2018 Bitcoin crash , and again a recent $500 billion Bitcoin plunge suggest the opposite might be true.
The other approach is to treat cryptocurrencies as “a purely speculative investment,” says Pereira. Viewed from that perspective, he says, a client should really only invest in cryptocurrencies with excess capital, just like any other speculative investment: “That way, their financial plan doesn’t blow up if crypto tanks again.”
Financial advisor and associate portfolio manager Guy Anderson of Parkview Financial in Toronto, says that, “More and more, I’m seeing investors who want to participate in cryptocurrencies without having to deal with digital wallets.”
With the rise of crypto ETFs and mutual funds, Canadians can now easily add cryptocurrency exposure to a portfolio – and for Anderson, this means it is now incumbent on all advisors to figure out how they will approach crypto with their clients.
Like Pereira, Anderson notes that “the role of bitcoin and other cryptocurrencies is often compared to the role of gold in a portfolio: as a defensive asset that provides an inflationary hedge. But just like gold, cryptocurrencies pay no dividend and issue no coupon, which means assessing and assigning a value remains an open question.”
“But valuation questions aside,” Anderson continues, “with the growth cryptocurrencies have delivered just in the last few months alone, and the increasing avenues for investors to participate in cryptocurrencies – whether that’s through closed-end funds, ETFs, or conventional mutual funds – advisors are doing a disservice to their clients if they don’t start having conversations about whether and how cryptocurrencies might belong in a client portfolio. That is, the question is no longer if, but how much?”
Anderson says that many of the DIY crypto investors who have approached him have taken aggressive crypto positions, allocating significant portions and, in some cases, even all of their portfolio to digital currencies. With those prospective clients, just as with his existing clients, Anderson takes a portfolio approach, digging into what proportion of a client’s investable assets should be allocated to cryptocurrencies.
Depending on the client, their risk tolerance and capacity, Anderson says he might recommend 1 percent of a portfolio be allocated to cryptocurrencies, with a higher allocation also possible depending on client variables.
Along with sorting out how to add crypto exposure to a portfolio is the question of how to handle crypto assets as part of your estate planning.
Former military officer and tech executive Sharon Hartung, author of Your Digital Undertaker and the forthcoming book Digital Executor: Unraveling the new path for estate planning , notes that if clients do not plan for their digital assets, including cryptocurrencies, those assets may become “invisible, inaccessible, or nontransferable” if the client loses capacity or dies.
For Hartung, cryptocurrency assets join other digital assets such as loyalty points, reward points, community platforms, cloud accounts, video channels, online hobby accounts, digital collectibles, non-fungible tokens (NFTs), and entertainment accounts as part of our growing “digital asset portfolios.”
She says that for both advisors and clients, “there is a shift in thinking required to deal with digital assets: We don’t have hundreds of years of legal precedents or experience to guide us here given there is a multitude of applicable, different, and new jurisdictional laws on the topics of fiduciary access, privacy, property rights and tax that are still years behind the wake of constantly evolving technology and the development of new types of digital asset classes.”
Hartung’s “bottom line” is that Canadians who are buying cryptocurrencies directly (not through ETFs or mutual funds) need estate plans setting out technical management instructions for fiduciary access and transfer instructions.
The direct purchase of cryptocurrencies also presents a unique risk – that of access. Given the nature of blockchains, there is no central authority or password reset for cryptocurrencies. The 2019 failure of Quadriga Fintech Solutions, owner and operator of Canadian cryptocurrency exchange QuadrigaCX, lead to the loss of up to $250 million owed to about 100,000 investors when Quadriga’s CEO and founder was reported to have died as the only person with access to Quadridga clients’ offline digital wallets.
With Bitcoin’s meteoric rise, ultra-wealthy investors are jumping into digital currencies, but with this space being a kind of “Wild West,” advisors are working to manage the speculative volatility of this asset within a larger diversified portfolio.