Noelle Acheson is a veteran of company analysis and member of CoinDesk’s product team.
The following article originally appeared in Institutional Crypto by CoinDesk, a newsletter for the institutional market, with news and views on crypto infrastructure delivered every Tuesday. Sign up here.
To the fanfare of vindication, the news dropped last week that two public pension funds were anchor investors in a blockchain fund managed by Morgan Creek. “The institutions are here!,” went the cry, “we knew it would happen!”. It echoed the chorus of jubilation that greeted the news late last year that Yale Endowment fund was dipping its sizeable toe into the blockchain sector via an investment in two crypto funds.
Much like that reaction, this one is overblown – but the news is positive, and highlights a few bigger-picture trends that point to increased institutional involvement.
First, let’s look at why it’s overblown.
- Technically, it’s not “two public pensions.” It’s actually two separate sections of the same investment program (Fairfax County Retirement Systems).
- These pension funds are not investing in cryptocurrencies, they are investing in a blockchain venture fund, which will mainly take equity positions in startups. The fund can hold a relatively small amount of cryptocurrency (up to 15 percent) but currently does not do so.
- The amount being invested is small, only $21 million, which is less than 0.3 percent of Fairfax County’s total pension AUM. 15 percent of that (the maximum that can be allocated to cryptocurrencies) is just over $3 million, a tiny drop in the ocean when it comes to the overall market.
- It is not at all unusual for a pension fund to invest in venture capital. Pension funds like venture capital. It’s not just the above-average returns (CalPERS, one of the largest pension funds in the world, confirmed last week that private equity was its best-performing asset class both long- and short-term), much-needed given the lackluster expectations for other asset classes. It’s also that they get to “mark-to-model”, which means it is valued at the expected price, not the market price.
But here’s the part we can get excited about: We are talking about pension funds, typically the most conservative type of fund there is. It’s not that we have here a pension fund being brave – they’re not allowed to do that. It’s that we have here a pension fund that sees blockchain investments as mature enough that unexpected bravery is not needed.
Also, pension funds like long-term investments. This decision, therefore, sends the constructive message that blockchain projects are not a quick turnaround.
And it’s worth noting that these are not just any pension funds. Fairfax County is the most populous and one of the wealthier areas of one of the wealthier states.
Its pension payment outlook is far from rosy, however. The two investing pension plans (employees and police) are respectively only 70 percent and 85 percent funded – they don’t have enough assets to meet their expected future liabilities.
To complicate the situation even further, the aging population means that, by 2025, the area is likely to have more people on pension than employees. This makes the need to find sources of “extra” return – even if it means more risk – increasingly urgent.
What ails Fairfax County can be seen across the country.
In 2017, the median funding ratio of public pension plans in the US was just over 70 percent – some states are at 30 percent. Better returns are becoming less of a “nice to have” and more of an imperative – this means that the risk profile of pension funds (for better or worse) is likely to change over the coming years, which in turn will encourage managers to look more closely at alternative investments with low correlation.
It is also significant, but not surprising, that the first pension fund forays into blockchain investment came from the public sector. A report released earlier this month by the Centre for Retirement Research shows that, in the US, 72 percent of public pension portfolios are in “risky assets” (equities and alternatives), vs. just 62 percent for private plans. This is more logical than it seems: Accounting rules dictate that private sector use a bond yield as the discount rate; public sector plans can use the expected rate of return on their investments. The higher the risk, the higher the expected return, and the lower the necessary funding.
So, while we can’t conclude that “the institutions are here” with this news – it’s not the turning point it may initially seem – we can expect to see more announcements like this as public pension funds around the US decide that blockchain-based investments, including crypto assets, have an acceptable – perhaps even desirable – risk profile.
Fund managers, especially conservative ones, tend to move as a pack, so this could happen relatively quickly. That doesn’t mean it will happen soon, though – the crypto asset market still needs some maturation in both infrastructure and liquidity. But the Morgan Creek announcement, plus a recent report from market researchers Cambridge Associates encouraging institutions to start looking at the sector, indicates that the shift has started.
Old and new image via Shutterstock