Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Crypto a no-go for instos: PGIM
PGIM believes that, beyond hedge exploiting inefficiencies to generate alpha on the other side of FOMO flows, “there is currently no compelling case for direct ownership of cryptocurrencies as a meaningful share of an institutional portfolio.”
“As long-term investors and fiduciaries on behalf of our clients, three things need to be true for us to add an asset class into a portfolio: the asset needs a clear regulatory framework, it needs to be an effective store of value, and it needs to have a predictable correlation with other asset classes,” said PGIM CEO David Hunt. “Cryptocurrency currently meets none of these three criteria. It’s much more of a speculation than an investment.”
PGIM’s research will be a boon for crypto’s discontents, who have long held that the asset class is not an effective hedge against inflation – especially when compared with gold, considered by many to be the world heavyweight champion of inflation protection – and that the emissions intensity of Bitcoin mining and transacting clashes with the move from institutions to ESG-based investing.
Cryptocurrencies are also growing more correlated to equities and commodities, calling into question claims that they act as an effective portfolio diversifier. Between 2013 and 2019, cryptocurrencies had a near-zero correlation with those two asset classes; that correlation spiked in 2020 and has remained consistently positive ever since.
“That an emerging asset class has a growing correlation with other assets as it matures is not only theoretically plausible but has historical precedent,” the report says. “Some frontier equity markets have demonstrated a similar tendency in the past.”
“It should therefore come as no surprise that as bitcoin has gone mainstream it has also grown more sensitive to the broader liquidity and risk sentiment factors that move other assets. In fact, market factor analysis demonstrates that bitcoin has developed a strong “trend following” tendency and more investors view bitcoin as a high-beta, risk-on asset.”
The outlook for cryptocurrencies as a whole is also challenged. While a few coins will “endure on the fringes of the monetary system”, the broad replacement of fiat currencies by cryptocurrencies – a story pushed by crypto-fanatics, with increasingly Messianic overtones – is unlikely to materialise.
“Functionally, cryptocurrencies are unable to meet the basic prerequisites of either a currency or a precious-metal substitute – shortcomings exacerbated by the powerful headwinds from increasing regulatory scrutiny and the growing likelihood of central bank digital currencies (CBDCs) which provide almost all the functional benefits of fiat-linked cryptocurrencies,” the report says.
Locally, super funds have been wary of embracing an asset they largely view as a fad, though some have taken on relatively small momentum-driven positions in “meme” stocks like GameStop (admittedly, even GameStop has a floor under it). Hindering further uptake of cryptocurrencies is the fact that no benchmark currently exists for the asset class under Your Future Your Super, leaving any potential takers highly exposed to failing the performance test.
Still, there are opportunities in a picks and shovels approach to the “incidental innovation” that has come about as a result of the flourishing of cryptocurrencies, such as blockchain and other technologies supporting the creation of CBDCs.
“Critically for investors, this broader ecosystem – and the tremendous innovation it is generating – has many companies, use cases and applications that are likely to endure regardless of the success of the cryptocurrencies that spawned them,” the report says.
“Indeed, many of these use cases are not limited to or reliant on cryptocurrencies at all.
The best opportunities for institutional investors may lie in this ecosystem rather than in cryptocurrencies themselves.”
