Where Does a Bitcoin ETF Fit in an Allocator’s Portfolio?

Earlier this month, the State of Wisconsin Investment Board, which manages became the first pension fund disclosed an allocation to bitcoin ETFs in its portfolio, $160 million split across an ETF from BlackRock and another from Grayscale. This allocation made headlines as SWIB became the first public pension to announce an allocation to a bitcoin ETF.

The SEC approved the first set of bitcoin ETFs in January, with offerings from Grayscale, BlackRock, ProShares, and Fidelity made available to investors for the first time. These spot ETFs track the price of the digital currency by holding it as its underlying asset, according to Fidelity. While the ETFs provide accessibility and exposure to bitcoin, they do not give an investor direct ownership of the digital asset.

In the first quarter of 2024, 563 institutional investors reported buying $3.5 billion worth of bitcoin ETFs, according to an analysis of 1Q 2024 13F SEC filings by Bitwise Asset Management CIO Matt Houghan. BlackRock’s IBIT ETF alone saw inflows from 414 institutional investors in the first quarter according to a 13F filing.

Although the number of allocators acquiring these ETFs is very small, spokespersons for two bitcoin ETF providers tell CIO that some pension funds are only starting to speak with their boards and investment committees about acquiring these ETFs and are in a learning phase on these kinds of investment products.

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Bitcoin ETFs can provide a level of liquidity that has not meaningfully existed with traditional cryptocurrency investments, as the ETFs also do not have the massive transaction costs that have traditionally been associated with owning cryptocurrency. The ETFs can also provide more security to investors, as exposure to crypto was made possible with these ETFs without having to use a traditional crypto custodian.

“Spot bitcoin ETFs have been a real game changer in terms of creating a structure where institutional allocators can have more confidence that they get exposure to the underlying asset class and don’t have the catastrophic risk of loss that has existed with other structures,” says Bob Elliott, co-founder and CEO of index provider Unlimited.

These ETFs have made exposure to crypto more attainable, but where do they fit into an allocator’s portfolio?

Attractive as a Diversifier and a Risk Asset

Institutional investors that are looking to add volatility to their portfolio and might have an opportunistic high-risk tranche within the portfolio could see crypto as a natural candidate for consideration in that sleeve, says Kevin Gallagher, principal at management consulting firm Casey Quirk, a Deloitte Company.

This type of allocation would still be a minority of a fund’s overall portfolio. While SWIB owns $164 million in these ETFs, its allocation represents a fraction of a percentage point of its $156 billion portfolio.

Over the past couple of years, bitcoin has transitioned from a period where it provided a higher beta version of tech equity risk to one where it has become “increasingly idiosyncratic,” Elliott says.

Questions remain for institutional investors: “Is it true idiosyncratic risk, or does it have certain hedging? Is it a higher beta version of tech-directed risk? Or is it a hedge particularly for certain risks, whether it’s geopolitical or inflation risks?” Elliott says.

We are still in the early days of understanding bitcoin, according to Elliott. The core question institutions have addresses bitcoin’s risk/return profile: Is it an asset that can reliably deliver a positive expected return or not?

Bitcoin ETFs are likely to be treated as a smaller diversifying asset that’s designed to create the opportunity for outsized returns or to introduce volatility to a portfolio in a way that is attractive, according to Gallagher.

Will More Funds Add Crypto ETFs?

Likely not, Gallagher says, “I don’t think we’ll see very many institutions make substantial allocations to this asset class, but we will see it used opportunistically, [ETFs] simplify the mechanism for how these groups can invest in the asset.” Most allocators do not have existing relationships with crypto custodians like Coinbase and Binance, but they likely have existing custodial relationships with some of the bitcoin ETF providers.

“The advantage of using the ETF is that every institutional investor already has the custodial relationships that allow them to hold the ETFs just like they’re able to hold stocks effortlessly and using the counterparties that they already know,” Gallagher continued.

Because we do not fully understand the return profile of bitcoin, this could prevent some allocators from investing in these ETFs. “The thing getting in the way of more significant allocations is that we still don’t have a clear picture of the underlying macroeconomic drivers of bitcoin and other cryptocurrencies as it relates to the rest of the assets in the portfolio,” Elliott says.

As barriers to entry come down, Gallagher expects some institutions to dip their toes in the water, with smaller allocations, small portions of their portfolio.

In March, the Government Pension Investment Fund of Japan issued a request for information on illiquid assets such as cryptocurrencies.