Investment Strategies

Asset Management Titan Blasts Cryptos, Says They Make Portfolios Riskier

Tom Burroughes, Group Editor, 20 May 2022

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For some time, there was evidence that the field of "digital assets" was going mainstream. As far as cryptocurrencies are concerned, and certain types in particular, dramatic falls in price have rattled confidence. A $1.4 trillion investment firm says that these entities don't smooth returns and protect against inflation.

Cryptocurrencies such as bitcoin are a “poor choice” for long-term investors and make portfolios riskier and more volatile, according to PGIM, a $1.4 trillion investment arm of US-listed Prudential Financial. 

The business fired a salvo at cryptos in the wake of the collapse in price of so-called “stablecoins.” (These  are cryptocurrencies that attempt to peg market value to some external reference – for example, fiat currency such as the dollar. Other stablecoins use algorithms or different methods to keep their values from fluctuating too much.)

Two main stablecoins from the crypto project Terra have collapsed with some calling the incident a Ponzi scheme. Terra dollar sister token Luna has fallen dramatically. UST lost its dollar peg when millions of investors sought to cash in on their tokens at the same time. Investors learned that the UST reserve mechanism was flawed – UST is an algorithmic stablecoin, backed by its sister asset Luna. 

In the already-febrile atmosphere of global markets, roiled by worries about rising inflation, supply-chain disruptions and a return to higher interest rates, the wider cryptocurrency market has suffered. Prices of bitcoin, for example, have fallen. 

“As long-term investors and fiduciaries on behalf of our clients, three things need to be true for us to add an asset class into a portfolio: the asset needs a clear regulatory framework, it needs to be an effective store of value, and it needs to have a predictable correlation with other asset classes,” PGIM chief executive David Hunt said. “Cryptocurrency currently meets none of these three criteria. It’s much more of a speculation than an investment.”

The drama adds to debate on whether cryptocurrencies can, or should, be a more “mainstream” area in which wealth managers can operate. A number of banks such as Julius Baer, Goldman Sachs, Morgan Stanley and JP Morgan are involved. Some banks have changed their tune dramatically – a few years ago JP Morgan CEO Jamie Dimon famously said he’d fire any banker trading in bitcoin. 

Even so, as this news service knows, there is still considerable interest among financial industry practitioners in cryptocurrencies and the underlying blockchain technology. (See an analysis of the digital assets space here.)

In PGIM’s latest Megatrends paper, Cryptocurrency Investing: Powerful Diversifier or Portfolio Kryptonite? dozens of investment professionals from across PGIM’s fixed income, equity, real estate, private debt and alternatives businesses dissect the most common pro-cryptocurrency arguments and find that direct investment in cryptocurrencies offers little benefit to an institutional investor – while adding considerable volatility and risk.

PGIM said that its research shows that cryptocurrency is an “unreliable portfolio diversifier and an inadequate safe-haven asset or inflation hedge,” according to a statement from the firm.

“Recent risk-adjusted returns are not much different than other asset classes but with more frequent and greater drawdowns. Furthermore, the unsettled regulatory backdrop and the significant environmental, social and governance concerns pose significant additional headwinds for long-term investors,” it said. 

“Cryptocurrency may be an heroic quest to build a viable, decentralised peer-to-peer payment system, but its pricing is based on speculative behaviour, rather than a fundamental thesis around its value or utility,” PGIM head of Thematic Research, Shehriyar Antia, said.  

PGIM also directed its fire at cryptocurrencies from an environmental, social and governance point of view. 

The firm said that a single transaction on the bitcoin blockchain is equivalent to two million transactions on the Visa network, or roughly the same energy needed to power the average American home for over two months, it said.

“Cryptocurrency gets all the breathless hype, but it’s the underlying technology where we find the most interesting investment opportunities,” Taimur Hyat, chief operating officer for PGIM, said. “Firms that enable real-world blockchain applications like clearing and settling transactions, preventing fraud, and tokenizing real assets offer significantly greater creation of value over the next decade. The old axiom applies – when there’s a gold rush, invest in shovels and pickaxes.”

More positively, the PGIM report said that private blockchains and smart contracts can “revolutionise elements of financial services, logistics, and supply chain management, as they eliminate the need for counterparty and trade verification as well as transaction and record reconciliation”.

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