Pension Funds and Cryptocurrencies
Pension funds typically cater to people investing for their retirement.
When it comes to retirement planning, most people stay conservative. Hence, pension funds were not allowed to invest in risky and unstable assets. However, the past decade or so has led to the creation of a new risky asset class.
For many years, cryptocurrencies have been considered to be an epitome of risk taking. However, now cryptocurrencies are the new kid on the block which investors cannot simply ignore.
The asset class has time and again proved its mettle by providing stellar returns to investors. However, these assets tend to be highly volatile. Hence, up until now, pension funds would simply steer clear of making an investment.
Milestone For Cryptocurrencies
Pension funds have recently started making some investments in cryptocurrencies. Most pension funds are not investing more that 1% of their overall portfolio in the crypto asset class. However, given the fact that pension funds control trillions of dollars, even a small investment generates massive demand. The end result is a self-fulfilling prophecy.
Pension funds are increasing allocation in cryptocurrencies since they are providing better returns. Also, since they are providing better returns the allocation is being increased.
At the present moment, pension funds have a significant amount of cryptocurrency which they are directly holding on their balance sheet. Even though, the allocations are small, the impact on cryptocurrencies is huge.
The fact that conservative investors such as pension funds are showing confidence in cryptocurrencies can be considered to be a milestone for these financial instruments. They were once considered a speculative fad which would die down on its own. Investment by pension funds sends a message to the investment community that cryptocurrencies are here to stay for the long run!
Geographical Trends in Cryptocurrency Investing
It needs to be noted that there are clear and obvious geographical trends when it comes to investment that has been made by pension funds in cryptocurrencies.
Pension funds belonging to the developed world are making significant investments in the cryptocurrency world. This is because regulators in these countries have given a tacit approval to their funds to make such investments.
On the other hand, the regulations are still quite strict in the developing nations and hence pension funds in the developing world are not investing in the crypto market at all.
There are several pension funds who are not comfortable making direct investments in cryptocurrencies. Hence, they are using the indirect route. These pension funds build crypto positions by investing heavily in stocks which have a large exposure to cryptocurrency.
Stocks like Tesla and Coinbase have been used by many pension funds for this purpose. This is because investment in equity does not count as an investment in alternative assets. Hence, if a pension fund buys stocks of Coinbase, they are not subject to the same regulation that they would have been in case they invested directly in cryptocurrencies.
Why Pension Funds Investing in Cryptocurrencies May Not be a Good Idea?
The cryptocurrency market has been in a remarkable bull run in the past couple of years. The end result is that the staunchest opponents of cryptocurrencies have also been won over. However, that does not mean that the risks associated with cryptocurrencies don’t exist any longer.
Some of the important risks have been mentioned below:
- Volatility: Cryptocurrencies can be highly volatile. It is not at all uncommon for cryptocurrencies to lose 10% to 15% of their value on a single day. This can be very dangerous for a pension fund.
Many people investing in pension funds do not have the time to stay invested for long periods of time. Also, they do not have the risk appetite because this may be their only source of income during retirement.
- Taxation: In many parts of the world, governments have started taxing gains from cryptocurrencies. The taxation rates are quite high. In a way, governments and central banks are trying to deter the world from using cryptocurrencies.
For example, in India, cryptocurrency investors have to pay a goods and service tax which can be as high as 28%! In many countries, losses from crypto investments cannot be offset with profits made in other investments. The fact that taxation rules keep on changing on a frequent basis also makes this asset class unpredictable and discourages people from making investments.
- Theft: Pension fund regulators are very particular about who has the custody of assets owned by the fund. This is because there is always a possibility of theft or embezzlement of assets.
In case of other asset classes, there are centralized custodian agencies which have been approved by pension fund regulators. However, when it comes to cryptocurrency assets, there are no fixed regulators.
There are various private entities who provide custodian services. However, very few are actually reliable. This is the reason that pension funds find it difficult to store cryptocurrency after they have made a purchase from the open market.
The fact of the matter is that cryptocurrencies have now become mainstream. As a result, even conservative investors like pension funds cannot afford to ignore them. However, there are still quite a few risks associated with cryptocurrencies which cannot be ignored.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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