With the total value of the market for digital assets approaching $2 trillion, it is natural and unsurprising that many investors are asking if digital assets should play a role in their portfolios. To answer that question though, we must first step back and ask how we determine which assets belong in a portfolio in the first place.
Is the portfolio a collection of assets that we think might appreciate in value, or is there a larger strategy in place?
For wise investors, the answer is unambiguously the latter. The guiding principle behind asset management starts with building a portfolio with effective asset allocation—choosing assets that have low correlations with one another, but positive expected returns over time. Thus, we need stocks and bonds in most portfolios because fixed-income tends to provide an anchor when equity values are falling.
In this context to assess whether or not digital assets belong in a portfolio, one should ask what their correlation is to other assets in the portfolio. If these digital assets have a low historical and expected future correlation to the existing portfolio, then adding some exposure to digital assets may make sense.
Beyond that point though, it becomes a question of what specific digital assets to add. This is an issue of security selection. At present, investors basically have two types of choices for digital assets—cryptos and NFTs or non-fungible tokens. Both are very risky investments, but cryptos are likely to be the safer and more stable between the two—for one thing, as of 2022, Bitcoin has been in existence for almost 14 years, suggesting at least some degree of longevity.
Even within the crypto landscape though, there are thousands of coins to choose among, and many of these are likely to have little or no value in the medium or even short term. There are significant concerns about fraud in the crypto market, and as such, any investments should be thoroughly vetted by an experienced professional.
NFTs represent a less liquid and more nascent area of the digital asset space compared to cryptos. While in theory, NFTs offer digital ownership of an asset, the legal basis for these claims is questionable, and NFTs do not generally carry any commercial rights to the underlying asset. Thus, NFTs are better thought of as collectibles—similar to an original movie poster perhaps or possibly a painting.
Against this backdrop, digital assets can make sense for certain types of investors, but the risks and rationale need to be assessed quite carefully before adding them to a portfolio.
Our next webinar will be Wednesday, June 15 covering Digital Asset Compliance and Related Issues. For another timely topic, William Jannace will discuss the regulatory challenges presented by digital assets and how brokerage firms and hedge funds can stay abreast of the evolving regulatory landscape. Regulatory approaches to digital assets by the SEC and FINRA will be discussed and the Biden Administration’s Executive Order on Crypto will be reviewed. Register and view the agenda for this complimentary webinar.
The SSC Learning Institute is a division of SS&C dedicated to providing continuing education for today’s professionals. Our webinar offerings are delivered by industry-leading subject matter experts and cover a wide variety of topics, from key regulatory updates and new investment vehicles to trending topics such as ESG investing and crypto. Learn more about the SS&C Learning Institute at ssctech.com/learn.