Today, Diari d'Andorra will be printing a special issue on Digital Transformation. It features a fascinating article by David Rabella, Director of Investments at Vall Banc Fons, on the inclusion of cryptocurrencies in investment portfolios.
See the original article on this link, page 39.
On the inclusion of cryptocurrencies in investment portfolios
The financial markets are in a permanent state of flux with new investment products and methodologies emerging all the time, which makes ongoing training essential to keep our investment portfolios on the cutting edge, being pioneers when it is called for. Today, asset-diverse investment methodologies (thanks to Markowitz) or the investment value techniques popularised by Warren Buffett, among others, are very much part of our standard practice. This has recently even extended to having financial derivatives in our portfolios, or even simple products like ETFs, which ten years ago were considered an afterthought.
All these methodologies and products were once innovative and adapted by certain pioneers before they became so widespread. When we consider adding any investment to our portfolio, we try to ask ourselves the same questions. Firstly, whether the investment has value; secondly, what risk we are taking on; and finally, but crucially, how the portfolio would function as a whole by incorporating this asset. Our role as portfolio managers is not about gambling on making a score in the future, but rather it is to make sure the likelihood of earnings outweighs potential losses. To make this happen, we investment professionals do more science than guesswork.
If we are convinced of anything at Vall Banc, it is that the technological revolution and the emergence of new ways of doing business means new players joining all sectors. This is equally true of the financial world, where lately there has been a revolution around blockchain technology, popularised by the so-called cryptocurrencies (the best-known being bitcoin and ether), which are simply the ones in this new ecosystem making the biggest splash in the media.
At Vall Banc Fons, we have set out to understand the cryptocurrency universe, attempting to separate the wheat from the enormous amount of chaff: all the disinformation and thousands of cryptocurrencies currently out there. After completing our investment analysis process, our conclusion is that it makes sense to add a small portion of ether in our portfolios, which we indeed did at the start of the third quarter of 2021.
We have selected ether or ETH (through a publicly listed, highly liquid instrument) because it is a way of taking advantage of the exponential growth of the ecosystem of smart contracts using blockchain technology. Ethereum is the network which trades the most and the commissions on these transactions are paid in the ether currency itself, the native currency of the Ethereum network, which in turn causes demand to rise.
We also believe that this network has an unmatched capacity to integrate changes in technology, for example, in terms of the environmental footprint, which we think will trigger a virtuous circle of greater transaction banking. Thus, this line of thinking has led us to believe that ether effectively holds value. What value it actually holds is an unknown variable that is hard to estimate, as it depends on many factors, such as the evolution of smart contract technology.
But if this technology ends up being more widespread, it undoubtedly has a much higher value than what current prices reflect. The second variable, risk, is also quite evident. The cryptocurrency universe, made up of more than 10,000 different coins, has a high mortality rate and an extremely high realised volatility. Consequently, if our theory is correct, we cannot turn a blind eye to this risk, which is why we have invested a sufficiently large amount so if it works, we come out on top, but at the same time an amount sufficiently small so that if we are wrong, the portfolio as a whole will not take a significant hit. Thirdly, in mixed portfolios, like most of those we manage, the aim is to ensure that poor performance by one group of assets is offset by others. To do this, despite the fact that the best long-term investment has historically been equity, the high market volatility is diluted by a combination of fixed income assets with lower prospects but ones that tend to offset downturns in equity investments.
But as we have often said, current fixed income prices, on the heels of the intervention of the central banks, have significantly swayed the markets in recent years, and this makes us think that this capacity for decorrelation may come into question. And so, the inclusion of cryptocurrencies, which perform independently from the yields from equity or fixed income investments, has led us to look favourably on adding this new type of asset to our portfolios.