Will wealth managers ever get on board with crypto?

The surg­ing pop­u­lar­i­ty of cryp­tocur­ren­cies and dig­i­tal assets in gen­er­al has caused con­ster­na­tion as well as excite­ment. In June, the Finan­cial Con­duct Author­i­ty (FCA) revealed that 2.3 mil­lion adults in the UK were hold­ing cryp­to assets, up from 1.9 mil­lion 12 months pre­vi­ous­ly. This prompt­ed the reg­u­la­tor to warn investors that they should “be pre­pared to lose all their mon­ey”. 

The suit­abil­i­ty of these assets for ordi­nary retail investors has been fierce­ly debat­ed, but what of the super-rich, the ultra-high-net-worth (UHNW) peo­ple who pos­sess enough cap­i­tal to safe­ly accom­mo­date high-risk invest­ments?

The UK wealth man­age­ment indus­try has yet to ful­ly engage with cryp­tocur­ren­cies. Many of the nation’s most estab­lished play­ers have refrained from invest­ing in them so far. 

Charles Stan­ley Direct is one of them. The firm’s chief ana­lyst, Rob Mor­gan, says: “We don’t con­sid­er cryp­to assets investable at present.” 

But he adds that the buzz being gen­er­at­ed by cryp­to invest­ments means that the sub­ject is com­ing up more in dis­cus­sions with clients. “We can’t ignore the sub­ject. It receives a huge amount of atten­tion from the pub­lic and the media, so we have to hold open and hon­est con­ver­sa­tions about what it is and the risks it pos­es.”

Tilney Smith & Williamson is anoth­er big wealth man­ag­er that has yet to take the plunge. The firm’s MD of cor­po­rate affairs, Jason Hol­lands, says that cryp­to invest­ments are hard to dis­cuss because the asset class is still at a “nascent” stage. 

“When con­struct­ing port­fo­lios for their clients, most wealth man­agers are high­ly focused on the risk/reward bal­ance,” he says. “This can be espe­cial­ly true in the case of UHNW clients, whose objec­tives often include pre­serv­ing the cap­i­tal that they’ve built up over time. They can actu­al­ly be less inclined than most to take unnec­es­sary risks.”

Oth­er wealth man­agers are unwill­ing to dis­cuss the sub­ject with clients. One of these is Rick Eling, invest­ment direc­tor at Quil­ter Finan­cial Plan­ning, who describes cryp­to as “fool’s gold”.

He believes that such invest­ments “should be con­sid­ered more akin to gam­bling. Their volatile nature means that you should be pre­pared to lose every­thing. Cryp­tocur­ren­cies are sim­ply not a legit­i­mate alter­na­tive to real invest­ments.”

Tra­di­tion­al invest­ment deci­sions use evi­dence-based assess­ments of a giv­en asset’s val­ue-cre­at­ing poten­tial. For instance, a wealth man­ag­er may choose to buy shares in a com­pa­ny because it is con­sis­tent­ly mak­ing big prof­its. Hol­lands says the high­ly spec­u­la­tive nature of dig­i­tal assets makes this a very dif­fer­ent sce­nario for port­fo­lio man­age­ment.

“They gen­er­ate no yield and it is ques­tion­able whether they have any intrin­sic val­ue,” he says. “Cyn­ics might say that cryp­to invest­ment is a clas­sic exam­ple of ‘greater fool the­o­ry’. That is, to know whether the price of an asset is low, fair or expen­sive in the absence of fun­da­men­tal val­u­a­tion mea­sures, you sim­ply invest in the hope that the next buy­er is will­ing to pay more than you have.”

Despite such crit­i­cism, more finan­cial insti­tu­tions are explor­ing how they might cap­i­talise on the atten­tion that cryp­tocur­ren­cies are attract­ing. One such firm is Wis­domTree, which is offer­ing a num­ber of cryp­to-based exchange-trad­ed funds and prod­ucts. 

The firm’s direc­tor of dig­i­tal assets, Ben­jamin Dean, accepts why wealth man­agers would want to steer clear of cryp­tocur­ren­cies. But he argues that, with the right mix of assets, an appro­pri­ate­ly sized cryp­to allo­ca­tion can increase a portfolio’s Sharpe ratio – an indi­ca­tion of how well an asset’s returns com­pen­sate for the lev­el of risk they oblige the investor to take on. 

“Our analy­sis has indi­cat­ed that mak­ing a 2% allo­ca­tion to bit­coin in a sam­ple glob­al 60:40 equity/bond port­fo­lio would have result­ed in a 0.5 per­cent­age-point increase in port­fo­lio volatil­i­ty, from 9.0% to 9.5%, and deliv­ered a return of 9.4% com­pared with 7.1% for a 60:40 port­fo­lio not fea­tur­ing bit­coin,” Dean says. “In effect, adding bit­coin improved the portfolio’s Sharpe ratio from 0.71 to 0.94. To give some per­spec­tive to that fig­ure, the MSCI All-Coun­try World Index returned 10.1% with 13.7% volatil­i­ty – equat­ing to a Sharpe ratio of 0.68 – dur­ing our peri­od of study.”

But it’s the lack of reg­u­la­tion that remains the main rea­son why many wealth man­agers feel that they can’t seri­ous­ly con­sid­er cryp­to invest­ments, despite the huge reserves and appetite for risk that some of their UHNW clients will undoubt­ed­ly pos­sess. 

“Insur­ers that pro­vide pro­fes­sion­al indem­ni­ty cov­er are wary when it comes to cryp­tocur­ren­cies. Very few are will­ing to under­write cryp­to risks, which presents a chal­lenge for wealth man­agers seek­ing cov­er,” says John Greene, divi­sion­al direc­tor at How­den Insur­ance Bro­kers. “The pro­fes­sion­al indem­ni­ty mar­ket is already chal­lenged, with busi­ness­es fac­ing high­er rates and cov­er­age restric­tions, so they are prob­a­bly choos­ing to avoid intro­duc­ing extra non-essen­tial risks such as cryp­to.”

The legal mine­field sur­round­ing cryp­to can­not be ignored, warns Kate Troup, a part­ner and spe­cial­ist in finan­cial ser­vices reg­u­la­tion at law firm Fladgate.

“It’s impor­tant for wealth man­agers to know that the FCA doesn’t want investors to be con­fused about whether or not a ser­vice offered by a reg­u­lat­ed firm is cov­ered by reg­u­la­to­ry pro­tec­tions,” she says. “If man­agers do want to pro­vide advice or man­age­ment ser­vices for cryp­to assets, this must be man­aged care­ful­ly from a com­pli­ance per­spec­tive. To pro­tect their rep­u­ta­tions, they will need to con­sid­er whether they have the appro­pri­ate in-house exper­tise to ensure that they can offer a sim­i­lar lev­el of ser­vice to that which they pro­vide for tra­di­tion­al invest­ments.”

For these rea­sons, many wealth man­agers are choos­ing to steer clear of cryp­tocur­ren­cies, notes Eling, who argues that there is no point in allo­cat­ing such assets for his clients until bet­ter safe­guards are avail­able. 

“We are like­ly to see a dev­as­tat­ing col­lapse in the cryp­to mar­ket one day,” he pre­dicts. “And I would not wish for our clients to be among the casu­al­ties.”