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Cryptocurrency: The pension fund odyssey
January 27, 2023
Navigating the ups and downs of the crypto market is not for the faint-hearted!
There are good reasons why pension funds should refrain from investing in the crypto and blockchain space. This industry is very young, extremely volatile, and technically complex. In addition, there is still no clear regulatory framework in terms of rules and regulations for the industry. But things are starting to move.
Unfortunately, traditional portfolios are not as efficient as they used to be and are barely making any money these days. Reduced diversification and declining real returns coupled with rising inflation are all problems facing defined benefit and defined contribution pension funds.
With these challenges in mind, pension funds, are taking a serious look at their allocations to cryptoassets, sometimes at the risk of their returns.
Pension funds in the age of contemporary finance
46% of Gen Z and 45% of Millennials want to access crypto through their 401(k). That's according to a study by U.S. asset manager Charles Schwab. These young, digital natives not only make up a larger share of plan participants and hold more assets, but also want a wider variety of options for investing via this type of account. So, it was only a matter of time until employees started discussing the idea of incorporating crypto into their compensation and 401(k) retirement plans.
This leads to a complicated challenge for pension funds: generating higher returns without compromising their expected performance. Capital inflows are not sufficient to cover anticipated outflows. As fund managers struggle to meet their return targets, they are also faced with investor demands for potentially riskier and newer products such as crypto-currencies or related products such as NFTs, coins and crypto assets; all while having to consider the prevailing fiduciary framework.
It makes sense, therefore, that pension funds, generally the most conservative of institutional investors, are more interested in the dynamic crypto/blockchain sector.
The debacle of Canadian pension funds
The cryptocurrency market has seen a rich evolution of fluctuations. There have been dramatic spikes and sharp drops, which has become the norm. Should we, therefore, blame Canadian pension funds for investing in a sector characterized by a "wild west" ethos and extreme volatility?
Indeed, during the year 2022, the crypto-currency markets experienced a sharp decline, resulting in significant losses for individuals and institutions. The Caisse de dépôt et placement du Québec (CDPQ) announced the total loss of its $150 million investment in the Celsius platform after it went bankrupt in July. Following this disappointing investment, the fund announced that it would no longer invest in cryptocurrencies.
Meanwhile, the Ontario Teachers' fund reported a loss on FTX after Sam Bankman-Fried's company filed for bankruptcy. In October 2021, he had initially invested $75 million in FTX International and FTX.US, and later in January 2022, he injected another $20 million into the FTX.US domain.CPP Investments (CPPI), one of Canada's largest pension funds, has decided to abandon digital assets without ever investing in them.
After thinking about this topic, it makes sense to examine it further. Over the years, observers have been skeptical of asset managers who think outside the box. They were criticized when pension funds started buying leveraged buyout funds, venture capital funds, small company stocks and so on Each time, the critics were wrong, as these stocks have since become core positions for pension funds.
And, if the cryptocurrency market adhered to this "today's mistake, tomorrow's success" logic, it is important for developers to be able to experiment with it in order to better understand this highly speculative sector and thus provide pension funds with more advantageous results.
Crypto: Can pension funds travel this road?
The riskiest investments in crypto-currencies are not the currencies themselves, but rather crypto-currency loans or shares in companies that serve the sector. These assets can potentially earn a return or offer profits for the company over time. However, there are a lot of uncertain factors and the expected performance is hard to predict. Therefore, the professionals in charge of managing these portfolios are highly paid to analyze each situation and make appropriate decisions.
Crypto-currencies have become a very attractive asset class for investors due to the higher returns they offer compared to banking products. Despite the risk associated with this alternative investment, pension funds can still tolerate short-term volatility due to a longer-term investment horizon. Trustees must consider this risk and carefully assess the impact.
Both traditional finance and the crypto sector offer advantages and disadvantages, however they interact to meet the changing demands of the financial market. It is possible that one day, when crypto-currencies become more prevalent and better understood as an investment vehicle, public pension funds may choose to adopt them. For pension funds, like it or not, are an integral part of the journey into the digital future proposed by crypto/blockchain technology and allow institutional investors to explore its full financial potential.
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