To The Moon

Back in April, I wrote a piece on Bitcoin on Substack laying out the investment case for long-term asset allocation. Since then, I've moved to publishing on LinkedIn, and BTC has gone from 60k to nearly 100k (well, almost!)

Re-reading the piece, I find it's still quite relevant, so I thought I'd repost it here. Enjoy!

April 8, 2024

In last week’s post, I discussed how to think about Gold allocations and promised that that would be a prelude to the ever more contentious case on Bitcoin.

I have been a crypto investor (admittedly as a macro tourist) since 2017 and had my fair share of glorious and painful stories to share. It has always been that ‘PA idea’ discussed among drinks my peers in the financial industry, but never really brought into professional work.

With the launch of spot Bitcoin ETFs however, this marks the beginning of crypto-assets becoming ‘real work’.

First of all, who are the big boys?

The real whales in the financial world do not make headlines like the hedge fund titans do. They are pension funds and sovereign funds - together managing US$30 trillion in global assets - that is almost 20% of global institutional AUM. They move slowly but when they move, it’s a multi-year trend and they drive booms in a whole industry - case in point, they increased private equity holdings from <10% to now 25% in the past 2 decades.

Crypto has been the candy in the shop window that these big boys were eyeing but wasn’t allowed to get because it wasn’t what ‘institutional investors do’ - the real significance of bitcoin ETFs is that it legitimizes crypto as an asset class. Indeed, the Big Boys have been enthusiastically investing in crypto-related PE/VC deals, including the now infamous FTX (and many others…). Now, the Big Boys can invest directly. Added to that there’s no need to pay PE funds the expensive carry - Bitcoin ETFs charges only 0.1%!

Japan’s GPIF, the world's largest pension fund, announced that they are considering Bitcoin as part of its investment portfolio. Why bother to make a big fuzz unless they are considering it a meaningful part of their long-term allocation?

The CIO’s mindset

But why would a Chief Investment Officer (CIO) at a pension fund consider adding Bitcoin to their asset allocation? These CIOs do not need to swing for the fences - their top concern is meeting return and volatility targets.

The problem is that many institions are missing their return targets. A CFA study shows that of corporate and state-sponsored defined benefit plans, 60% say it is likely or very likely that they will not meet their return targets. CalPERS targets a 7.5% return but had been achieving only 5.1%.

So where to get the extra return without increasing your volatility? Luckily, Fidelity gave you an answer: their analysis suggests you can keep volatility constant by adding 3% to a 60/40 portfolio, if Bitcoin returns only 15.5% annually!

Moreover, your constituents are increasingly asking for Bitcoin allocation - 50% of those who are below 45 already invest in crypto themselves (below from CFA survey in 2022, given the rally since then, these numbers have surely gone up…)

So, where should this 3% allocation come from? The answer aligns with the logic applied to gold in last week’s discussions: bonds! Indeed, sovereign wealth funds have already been reducing their fixed income holdings in the past 2 decades:

How high is the moon?

With the global institutional AUM at $165 trillion, every 1% allocation to Bitcoin represents a US$1.65 trillion inflow over the next decade. Let’s say it takes 10 years to achieve 1% allocation, taking a simple average translates to US$165bn every year. Compare this with the current Bitcoin market cap, which currently stands at ~$1 trillion when accounting for lost coins. The annual flow would be 16.5%!

So far, the newly launched Bitcoin ETFs have attracted US$37bn inflows in 3 months, so the annualized rate has been ~$160bn, which seems to be track.

As far as the question of how much to allocate to Bitcoin, if Gold warrants a 15% allocation, Bitcoin could command 25-30% of that figure, aligning with the 3-4x higher volatility of Bitcoin vs Gold.

TTM Wen?

Every Bitcoin bull points to its halving event in April and how much Bitcoin rallied post halving historically. I’d argue that this event has now been partially priced in - in none of the past halvings Bitcoin was trading at its ATH.

For institutions, what’s more important goes back to my first point about legitimacy. Now that we have the vehicles, you need someone to give you the license to drive - and that’s a BUY rating from bulge bracket banks…which will surely come when these banks start to offer crypto products to their clients.