Setting Boundaries: Defining Active and Passive Management for Crypto

This week Max Freccia from Truvius shares his perspectives on active vs. passive management and how these different investment models – well-defined in TradFi – can be applied to cryptocurrency investing. Many crypto investing tools have been launched, including SMA platforms, portfolio tools and ETFs. Max covers simple buy-and-hold strategies, automated indices and discretionary management and the pros and cons of each of those.

It’s fascinating to see the maturity of this asset class happening before our eyes and the different models emerging to support client interest and help advisors navigate their path into digital asset investing. As tools emerge for advisors, they can determine how to include this asset class alongside their traditional investment business. Since the British Standard Chartered Bank has forecast a 2024 BTC price of $120,000, up from $100,000 in April, advisors can expect clients to initiate conversations.

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For perspective, consider that in a 2019 study, Yale Economist Aleh Tsyvinski proposed that investors should consider holding 6% bitcoin in their portfolios, recommending “that even the staunchest opponents of the cryptocurrency world are best off investing 1% of their assets in this space, if only for diversification purposes.”

Four years later (eons ago in the crypto space), a Google search today asking, “How much should I invest in crypto,” will highlight various sources supporting an investment between 1% and 6%, with other recommendations as high as 12%.

As advisors, you need to support clients interested in crypto investment, but which investment strategy will you take? Will you consider an active or passive investment model when advising your clients?

Down below we have links to other resources in the keep reading section for those interested in continued reading on today’s topic.

If you have questions for our Advisor network or have topics you’d like to see covered, get in touch, and we will try to answer them in future editions of Crypto for Advisors.

– S.M.

Setting Boundaries: Defining Active and Passive Management for Crypto

Advisors should be provided with clearer definitions of active and passive management for digital assets to make more informed portfolio choices for their clients

– Max Freccia

Since the creation of index funds, allocating between active and passive management remains the subject of great debate among investors. Over time, the boundary lines between active and passive investment vehicles for traditional asset classes have become better defined, benefiting from decades of analysis and product development. Unfortunately, the same cannot yet be said for crypto investment products.

Advisors investing in established asset classes today are tasked less with disentangling “active” vs. “passive” and more with determining how much active risk to take on for clients, and choosing the most sensible ways to do so from an accessible, well-populated landscape of highly competitive investment vehicles.

The task is doubly challenging for advisors interested in digital assets because “active” and “passive” investment options are still only nascently defined and starkly lacking in sophistication and ease of access.

What does “active management” look like for crypto today? The following framework lays out the crypto investment landscape currently available for advisors, divided into three categories with pros and cons for each as well as their active or passive nature.

1. Single Token Buy-and-Hold

Often implemented directly via exchanges through separately managed account platforms (SMAs) or investment trusts (especially in the absence of SEC-approved spot ETFs), buy-and-hold is the most simplistic way to add digital assets to an overall portfolio.

Pros:

• Direct access to crypto
• Low portfolio management overhead
• Potentially more accessible via advisors’ existing wealth technology platforms

Cons:

• Lack of diversification
• Clients can independently obtain exposure
• Potentially outsized management fees for naïve exposure
• Certain vehicles may introduce unintended risks

Active vs. Passive: This represents passive exposure to a subset of digital assets (commonly BTC and ETH) but without the diversification and risk-management benefits of typical rules-based passive indices.

2. Automated Indices

Automated indices provide a rules-based framework for crypto exposure to a broader number of assets (often the top 10-25 assets by market cap) and systematically rebalance to meet portfolio construction goals. Currently, U.S. investors often access these products through multi-asset SMAs.

Pros:

• Improved diversification and outperformance potential vs. single-token exposures
• Rules-based portfolio construction creates consistent exposure to the broader crypto market

Cons:

• Current options often lack nuanced thematic or sector-specific allocations or personalized customization
• Typically higher-touch onboarding process vs. individual buy-and-hold
• Potential underperformance vs. actively managed products

Active vs. Passive: While some tout the automated nature (i.e., rebalancing) of these products as “active,” these should be considered purely passive exposures akin to index funds for traditional asset classes.

3. Quantitative or Discretionary Management

Active managers construct strategies that leverage discretionary blockchain expertise and quantitative on-chain analysis to provide sophisticated crypto exposures. These are often accessed via hedge funds or specialized SMAs.

Pros:

• Institutional-grade expertise for a rapidly developing and technical asset class
• Potential for risk-adjusted outperformance and/or reduced correlation to the market
• Often superior risk management and trade execution

Cons:

• Accessibility hurdles often exist, including limited capacity or high investment minimums
• Manager selection may be challenging due to shorter track records
• May exhibit periods of underperformance vs. passive products

Active vs. Passive: This represents true active management commensurate with standards for traditional asset classes.

Bringing Crypto Investment Products into Focus

The developing nature of the digital asset investment product landscape leaves the delineation between active and passive investment products, and how to access them, fuzzy at best. Ultimately, more clearly defining the available active and passive options and how they relate to traditional investment evaluation frameworks will equip advisors to more confidently select the most appropriate digital asset solutions for their clients.

Ask an Advisor

With the rise in interest in crypto following the BlackRock ETF application, we have been getting more questions regarding portfolio allocation.

– Adam Blumberg

Q: How do I view crypto in a portfolio?

A: We usually consider crypto an Alternative Asset based on the risk characteristics. However, most Alts are illiquid and only available for accredited investors with high minimums. Crypto is incredibly liquid and available to any investor with virtually no minimum investment.

The risk is the critical part here, however. Advisors must ensure the client can stand to lose all their crypto investments.

Q: Should I plan to rebalance?

A: That depends on the investment thesis, risk profile of the client, etc.

If you’re investing in bitcoin for the long term, as a multi-year inflation hedge, then you will probably keep it for several years. If you’re choosing an allocation to crypto as part of an overall risk management and diversification strategy, then you probably rebalance quarterly (an approach that has outperformed the S&P).

Q: Should my clients hold crypto or a fund?

A: To make this decision, first consult your compliance department and what they will allow. Of course, a bitcoin spot ETF may be on the way this year, but there are already several ETFs and other investments that give exposure to crypto and are already approved. Those funds are much easier to put into retirement accounts as well.

Holding actual crypto is holding a bearer instrument. It takes more technical know-how and carries some technical risk.

Again, it depends on the investment thesis. If you want to get your clients exposure to the upside without having to learn wallets and other custodial technology, funds are the way to go. If you and your clients subscribe to more long-term and revolutionary theses, holding crypto in wallets would work.

Keep Reading

U.S. crypto exchanges transact less than 10% of the world’s crypto trades. As adoption grows in the U.S. market, that market share will likely have to grow to support onshore trade and settlement.

Institutions and investors surveyed by PWC in Asia state self-custody as challenging and inflexible when trading crypto. These same issues will impact advisors actively managing clients’ crypto investments as adoption grows.

How will crypto investments work with 401Ks? Advisors are starting to include crypto holdings as part of retirement savings accounts. Will the same active and passive considerations continue?