February 11, 2021

Growing Number of Pension Funds, Endowments, Foundations Adding Bitcoin to Portfolios

The digital asset is gaining more acceptance among institutional investors.

Reported by Ellen Chang

The number of pension funds, endowments, and foundations adding Bitcoin to their portfolios has steadily risen over the past couple of years as the digital asset has gained more acceptance as an alternative asset.

Two pension funds in Fairfax, Virginia, began investing in late 2018 and 2019 in blockchain technology and Bitcoin through investments in two Morgan Creek Digital funds, which many consider the first investments in the crypto asset from a US pension fund. And a number of hedge funds, family offices, pension funds, endowments, foundations, asset managers, registered investment advisers (RIAs), and banks own Bitcoin outright through Boston-based Fidelity Digital Assets.

The world’s largest asset manager, BlackRock, recently said it is entering into the cryptocurrency business, according to US Securities and Exchange Commission (SEC) filings. BlackRock, which manages $8.7 trillion, said in its SEC filings that it is seeking to add the Bitcoin futures investments to the BlackRock Global Allocation Fund and the BlackRock Strategic Income Opportunities Fund.

Even Massachusetts Mutual Life Insurance Co. has sought exposure, buying $100 million worth of Bitcoin in December through NYDIG, a New York-based fund management company. Tesla, the California electric car manufacturer, said on Feb. 8 that it purchased $1.5 billion worth of Bitcoin, prompting the price of the digital coin to rise to $44,000. Marathon Patent Group, a Las Vegas-based Bitcoin mining company, saw its shares rise exponentially to $37.59 on Feb. 9 from a 52-week low of $0.35.

Interest from institutional investors could be behind the recent increase in the value of the digital asset. Bitcoin has risen 285% from a year ago, but the cryptocurrency has faced extreme volatility in the past few years. It was down nearly 14% in early January after reaching an all-time high of $41,940 earlier in the month, but rose to $46,597 on Feb. 9. The digital asset also lost billions of dollars in market cap between 2017 and 2018—in December 2017, Bitcoin reached a then-record high of nearly $20,000, but by February 2018, it had dropped below $8,500.

Bitcoin was launched in January 2009 by an unknown person or group of people in the aftermath of the Great Recession. But even after more than a decade of existence, determining the number of pension funds that have invested in Bitcoin remains challenging since public pensions do not have to disclose their specific holdings, just their annualized growth.

In September 2018, the Fairfax County Police Officers Retirement System committed $11 million to the Morgan Creek Blockchain Opportunity Fund I, said Katherine Molnar, chief investment officer of the pension fund. The pension fund had a market value of $1.63 billion as of Dec. 31, and 1,427 active law enforcement officers and 1,202 disabled or retired officers. In October 2019, the pension fund committed $22 million to the Morgan Creek Blockchain Opportunity Fund II. The pension fund made another $2.5 million commitment to the second fund in December.

The pension fund wanted to have exposure to Bitcoin through a venture capital (VC)/private equity (PE)-type fund, Molnar said. The two Morgan Creek Blockchain Opportunity funds invest 80% of their funds in companies that use blockchain technology and 20% in assets that can be invested in cryptocurrencies such as Bitcoin , she said.

Since Bitcoin and other cryptocurrency prices are often volatile, investing in the Morgan Creek funds is similar to having an allocation in a venture capital fund, Molnar said.

“We saw a tremendous opportunity in blockchain technology and to some degree into the cryptocurrencies,” she said. “The average price Bitcoin was acquired was in the $5,000 to $6,000 range.”

Having less direct exposure to Bitcoin was the goal of the pension fund since it remains unknown which digital asset will “rise to the top,” Molnar said. “Many sectors could benefit from blockchain technology. We are being opportunistic since the technology is going to catch on.”

The Fairfax County Employees’ Retirement System (FCERS) committed $10 million to the Morgan Creek Blockchain Opportunity Fund I in the fourth quarter of 2018 and $33 million to date to Morgan Creek Blockchain Opportunity Fund II in the fourth quarter of 2019, said Andrew Spellar, chief investment officer of the pension fund. The commitments represent a 1% targeted position of the plan’s assets.

As of Sept. 30, Fund I was 95% drawn and valued at $13.4 million, or a net benefit of an increase of 40.7%, and Fund II was 90% drawn and valued at $35.8 million, or a net benefit of an increase of 20.7%. There have been no meaningful distributions to date, he said. (December 31 valuations will be due this month.)

The pension fund had an estimated market value of $4.7 billion as of Dec. 31, and the defined benefit (DB) plan covers all non-public safety personnel for the county’s government, adding up to 8,421 active employees, and all non-educators for the county’s public school system with 5,783 active employees, plus 9,824 people and retirees and other beneficiaries as of June 30.

Spellar echoed Molnar’s investment strategy and outlook about the Morgan Creek funds.

“Given that both funds are 80% to 85% focused on venture capital equity investments in companies centered on blockchain technology, within our risk model we used similar characteristics as venture capital,” he said. “However, given the uncertainty around the 15% to 20% liquid cryptocurrency position, the allocation was halved. Liquidity is assumed to be none for much of the life of the fund, again adjusted for the uncertainty in the liquid crypto portion.”

The pension fund is broadly diversified across alternatives with 20% allocated to hedge funds, 9% to private credit, 3% to private equity, 3% to private real assets and other real asset exposures such as 4% commodity futures and a 2.5% gold futures overlay, Spellar said.

While some institutional investors have viewed cryptocurrencies as a gold substitute, the pension fund has “no position on that,” he said. “We look at this as a PE/VC investment in blockchain applications, of which cryptocurrency is just one.”

Both pension funds underwent an extensive and “very rigorous legal due diligence” into the Morgan Creek funds that took three months before an investment was made, Spellar said.

“We like the concept of investing in the equity of startup companies using blockchain technology,” he said. “There are a lot of applications for decentralized ledgers, even for banks. Bitcoin was just another part of it.”

While Spellar said Bitcoin is an intriguing asset, the pension fund does not plan to make a direct asset allocation into the digital asset.

Institutional investors have also viewed Bitcoin as an alternative currency since its correlation to stocks and other asset classes had been very low. Bitcoin’s correlation to the S&P 500 is now 0.34 over the past year compared to 0.14 over the last five years, wrote Sean Bill, CIO of Santa Clara Valley Transportation Authority in California, on Feb. 9 in a newsletter. Bitcoin’s benefit as a diversifying asset will decrease as it attracts more investors.

“On a forward-looking basis, it still offers value, but as more investors enter the market the correlation to other asset classes is likely to continue to increase and thus reduce its benefit as a diversifying asset,” he wrote. “If I were recommending bitcoin to my board today, I would suggest an allocation of 0.50% to 1.5%, instead of the 0.50% to 3.0% weight I suggested in 2019. An allocation still makes sense, but in smaller size.”

Investing Directly into Bitcoin

Other institutional investors want to invest directly into Bitcoin. One option is for them to buy, sell, and store the digital asset through Fidelity Digital Assets. The company created its own wallet and cold storage in 2017 so that the digital assets are held offline. Buyers can also execute trades with other cryptocurrency exchanges and the private key is held by Fidelity so ownership of it is not a concern.

The investment and retirement provider has more than 100 institutional clients that own Bitcoin as of January, a growth rate of four times from December 2019 to December 2020. In the third and fourth quarters of last year, the amount of investments into Bitcoin had grown steadily, but the pattern of buying and selling the digital asset had been somewhat inconsistent, said Christine Sandler, head of sales and marketing at Fidelity Digital Assets.

“We have seen consistent overall pick-up in the activity in the past two quarters,” she said. “Growth was built around the global macro narrative. 2020 was been a breakout year for institutional growth of Bitcoin adoption.”

The last two quarters of 2020 brought more newcomers into the space and more investors from the traditional side, such as hedge funds, RIAs, family offices, and asset management firms, Sandler said.

Fidelity’s first institutional Bitcoin was in 2018 and today numerous hedge funds, family offices, pension funds, endowments, foundations, asset managers, RIAs, banks, and cryptocurrency native companies such as crypto mining companies own Bitcoin through the company, she said. Sandler declined to comment on the market capitalization of Bitcoin being invested by clients.

Some clients have used Bitcoin as a digital asset to be “opportunistic around the price and also part of an arbitration strategy,” said Sandler, former director of institutional sales at Coinbase.

This year, Fidelity could “anticipate adding Ethereum” since this digital asset, like Bitcoin, has regulatory certainty, she said.

Harvard, Yale, Brown, and the University of Michigan, which are some of the largest university endowment funds in the country, have been rumored to have added cryptocurrency to their portfolios. The endowment funds added the digital asset in the past year by buying Bitcoin through exchanges such as Coinbase, CoinDesk said in an article, citing two unnamed sources. Harvard remains the largest university endowment with more than $40 billion in assets while Yale has over $30 billion.

In 2018, Yale University Chief Investment Officer David Swensen was rumored to have invested in cryptocurrency venture funds managed by Andreessen Horowitz and Coinbase co-founder Fred Ehrsam and former Sequoia Capital partner Matt Huang, according to a CNBC article.

Investing via Bitcoin Futures Contracts

A number of institutional investors that want to take on less risk invest by allocating money into the CME’s Bitcoin futures contracts that were launched in December 2017. Each contract is worth five Bitcoins.

Interest in Bitcoin futures and options skyrocketed last year as investors sought a way to hedge risk on significant Bitcoin price movements, said Tim McCourt, CME Group global head of equity index and alternative investment products. The number of large open interest holders grew to a record of 110 in the first week of December, which was an indication of strengthening institutional interest. Open interest holders are investors who have 25 or more Bitcoin futures contracts. The CME said it could not name its clients.

The average daily volume reached 11,179 futures contracts in December, up 114% year-over-year, which was the equivalent of 55,900 Bitcoins. Since 2017, more than 6,700 unique active accounts have traded Bitcoin futures, while 3,050 accounts were added last year, an increase of 84% from 2019.

“It’s been a really great few years and adoption has continued to increase,” McCourt said.

Since Bitcoin futures contracts are settled in US dollars and regulated, these synthetic assets give institutional investors the “exposure to the digital asset, but they don’t have to handle it or deal with custodying the asset in a wallet,” McCourt said. “You just get the price performance, make an allocation to it, and can hedge against other parts of the portfolio if you already hold Bitcoin itself.”

Trading for Ethereum futures began on Feb. 8 on the CME.