Will wealth managers ever get into crypto?

The growing 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 held crypto assets, up from 1.9 million 12 months earlier. 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 hotly debated, but what about the super-rich, ultra-wealthy (UHNW) people who have enough capital to fit comfortably security to high-risk investments?

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

Charles Stanley Direct is one of them. The firm’s chief analyst, Rob Morgan, says, “We do not consider crypto assets to be investable at this time.”

But he adds that the buzz generated by crypto investments means the topic is coming up more in discussions with clients. “We cannot ignore the subject. It gets enormous public and media attention, so we need to have open and honest conversations about what it is and the risks it poses.

Tilney Smith & Williamson is another great wealth manager that has yet to take the leap. The firm’s Chief Business Officer, Jason Hollands, says crypto investments are difficult to discuss because the asset class is still in a “nascent” stage.

“When constructing portfolios for their clients, most wealth managers focus heavily on the risk/reward balance,” he says. “This can be especially true in the case of UHNW clients, whose goals often include preserving the capital they have accumulated over time. They may in fact be less inclined than most to take unnecessary risks.

We do not consider crypto assets to be investable at this time, with respect to our client accounts

Other wealth managers don’t want to bring up the subject with their clients. One of them is Rick Eling, chief investment officer at Quilter Financial Planning, who describes crypto as “fool’s gold.”

He believes that such investments “should be considered closer to gambling. Their volatile nature means you have to be prepared to lose it all. Cryptocurrencies are simply not a legitimate alternative to real investments.

Traditional investment decisions are based on factual assessments of the value creation potential of a given asset. For example, a wealth manager may choose to buy stock in a company because it consistently makes large profits. Hollands says the highly speculative nature of digital assets makes it a very different scenario for portfolio management.

“They don’t generate any return and one wonders if they have any intrinsic value,” he says. “Cynics might say that investing in crypto is a classic example of ‘biggest fool theory’. In other words, to know if 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.

Despite these criticisms, more and more financial institutions are exploring how they could capitalize on the attention that cryptocurrencies are attracting. One such company is WisdomTree, which offers a number of crypto-based exchange-traded funds and products.

The company’s director of digital assets, Benjamin Dean, agrees why wealth managers would want to avoid 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 offset the level of risk they take on. oblige the investor to take.

“Our analysis indicated that making a 2% allocation to bitcoin in a sample global 60:40 stock/bond portfolio would have resulted in a 0.5 percentage point increase in portfolio volatility, from 9.0% at 9.5%, and produces a return of 9.4% compared to 7.1% for a 60:40 portfolio that does not contain bitcoin,” says Dean. “Indeed, the addition of bitcoin improved the portfolio’s Sharpe ratio from 0.71 to 0.94. To give this number some perspective, the MSCI All-Country World Index returned 10, 1% with a volatility of 13.7%, which equates to a Sharpe ratio of 0.68, over our study period.

But it is the lack of regulation that remains the main reason many wealth managers feel they cannot seriously consider crypto investments, despite the huge reserves and risk appetite that some of their UHNW clients have. will undoubtedly possess.

“Insurers who offer professional indemnity cover are wary of cryptocurrencies. Very few are willing to underwrite crypto risk, which presents a challenge for wealth managers looking for cover,” says John Greene, Division Director at Howden Insurance Brokers. “The professional indemnity market is already challenged, with companies facing higher rates and coverage restrictions, so they are likely choosing to avoid introducing non-essential additional risks such as crypto. “

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

“It is important for wealth managers to know that the FCA does not 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 wish to provide advice or management services for crypto assets, this must be handled carefully from a compliance perspective. To protect their reputation, they will need to consider whether they have the appropriate in-house expertise to ensure they can deliver a level of service similar to what they provide for traditional investments.

For these reasons, many wealth managers choose to avoid cryptocurrencies, notes Eling, who argues that there is no point in allocating such assets to its clients until better collateral is available.

“We will likely see a devastating crypto market crash one day,” he predicts. “And I wouldn’t want our customers to be among the victims.”

Dolores W. Simon