Asset allocation is the decision process of investing in the major categories of investments such as cash, bonds, stocks, real estate, commodities etc. Each asset class has different levels of risk, return, and correlation between each other. As trusted advisors it is our job to consider the unique needs of each client and to allocate their investments appropriately.
According to a research study by the CFA Institute, more than 90% of a portfolio’s returns can be explained by the allocation process amongst asset classes, as opposed to specific security selection. Explained in a different way - the decision to invest in stocks is more important than deciding which specific stocks to invest in.
How does Northland Wealth make the decision to change asset class weights? Or how do we decide to include a whole new asset class such as cryptocurrencies? We first need to clearly formulate a market outlook, forecast how each asset class will perform, and then figure out the relationship, or correlation, between the various investments. Remember, the ultimate objective is to increase return per unit of risk taken. The way the math works is that you want to add assets with lower correlation to other assets in the portfolio – although on its own it may be more volatile.
To study the cryptocurrency asset class, members of the Northland Wealth investment team have traveled extensively and met with many of the most prominent investors and thought leaders. Some of these include:
• Galaxy Digital (the NYC family office of billionaire Mike Novogratz);
• Fidelity Digital Assets (the Boston based subsidiary of the $2.46 trillion family owned asset manager); • Greyscale (the $3 billion cryptoasset manager);
• Dan Morehead, (a former Tiger Cub) Founder of Pantera (the world’s highest performing hedge fund - 86x in 5 years);
• Nic Carter and Matt Walsh of Fidelity backed private equity firm Castle Island Ventures;
• Mark Yusko and Anthony “Pomp” Pompliano (who host the ‘Off the Chain’ podcast) of Morgan Creek Capital;
• David Nage of the Baselayer podcast and Arca (an institutional investor);
• Gabor Gurbacs of the $60 billion asset manager VanEck (a firm that is at forefront of educating the institutional crowd on this asset class and is one of the companies that until recently was pursuing the creation of a Bitcoin ETF); and
• thought leader, Pierre Rochard of Krakken (a large currency exchange).
There are also thousands of hours we at Northland have spent reading, listening to podcast interviews, attending conference presentations and calls involved in this research.
Elsewhere in this edition of the Artisan we talk about how negative interest rates usher in a new age in financial history. Northland’s asset allocation draws a line between these concepts, as we believe the appeal of crypto and especially Bitcoin is elevated considering greater uncertainty around the monetary policies employed by central banks globally.
The decision to include a new asset class is very complex and taxing. Deciding on the investment to represent this view is equally difficult and nuanced.
After making the decision to include a new asset class, Northland’s team scours the investable universe to identify the most suitable investment. In the lens of cryptocurrencies, we consider whether we should invest in the physical cryptocurrencies, or a company that supports the ecosystem and will benefit from increased adaptation or utilization.
This type of asset has unique return characteristics with asymmetric returns - meaning profits are more skewed toward the upside than the downside. Portfolio management would dictate that it would be most appropriate in tax sheltered investment vehicles. Have you tried to buy bitcoin in your TFSA? We were able to identify a solution that could be invested within that will shelter clients’ gains.
There are also specific operational due diligence concerns we review, and which were described in detail during previous editions of the Artisan. For example, for this asset class we were most concerned about custodianship of the physical keys – who holds these on behalf of our clients? And where? How safe is this solution?
In isolation, cryptocurrencies are very volatile, but as part of a portfolio, they perform an important role in protecting our client’s investments. The road ahead will be bumpy, but we have high confidence in the longterm prospects of this asset class.