Perspective on Bitcoin

Telemus Weekly Market Review January 8th, 2024 - January 12th, 2024

On Wednesday January 10th, the Securities and Exchange Commission approved 11 exchange traded funds (ETFs) that seek to provide investors with exposure to Bitcoin. These ETFs are the first SEC approved avenues for investors to access physical exposure to the Bitcoin market. In light of the SEC’s recent approvals, we wanted to provide our perspective on how we are considering the asset class.

For starters, investors should be cognizant of the type of asset they are purchasing. Given that Bitcoin was designed as a digital currency, at first blush one might classify Bitcoin as a currency similar to the dollar or euro. Currencies serve as a store of value and the volatility in the price of Bitcoin makes it challenging to comply with this trait.  Its lack of sovereignty, on the other hand, draws parallels to gold that has been viewed by some investors as a both a store of value and diversifying safe haven asset as well. Cryptocurrency and gold are also similar in that neither produces cash flows, which make the valuation of the asset more challenging and unique. However, gold has uses outside of just serving as a store of value (i.e., in jewelry or as a conductor), which makes the comparison less than perfect. 

While there are some promising use cases for Bitcoin, such as facilitating electronic payments, there isn’t broad adoption at this time. In addition, Bitcoin isn’t the only cryptocurrency and there have been numerous stories of new cryptocurrencies that have been created, become popular, and then fizzled out. We don’t dispute the potential for digital currencies to play a role in the payment ecosystem down the line. However, we also know that the industry will evolve and that many central banks, including the U.S. Federal Reserve, are considering developing their own digital currencies that could ultimately compete for share of the cryptocurrency market. Given all this, should cryptocurrency adoption evolve, it remains less clear how the market share of various tokens will level out over time.  

As we contemplate the collective of these considerations, we currently believe it’s best to classify Bitcoin as a speculative asset. Thus, one owns it because they think it will go higher in price and not because it meets a strategic allocation within an investment portfolio. 

Bitcoin in Portfolios

Given our viewpoint of Bitcoin being a speculative asset, the Telemus Investment Committee does not presently have an allocation to Bitcoin in client portfolios. In addition to the considerations we discussed above, its elevated level of volatility makes it hard to incorporate in a portfolio without Bitcoin having undue influence on the overall risk. Previous research on the topic indicated from 2017-2022 Bitcoin had an annualized standard deviation of 80%ⁱ, or approximately five times that of U.S. stocks. From a diversification standpoint, the same research noted there tends to be little to no correlation between cryptocurrencies and stocks in normal times. However, during periods where equities have fallen by 20% or more, the correlation with the S&P 500 jumps to 0.55. This would indicate that the diversification properties haven’t been beneficial at the times you really need it, such as when equity prices have an outsized pullback. 

Collectively, this analysis leads us to the view that at this time Bitcoin and cryptocurrencies don’t have a broader role in a strategic asset allocation. Should one want to speculate on the value of the asset, in our view, that decision should be made outside of their portfolio’s long-term strategic allocation.

Drivers of Interest in Bitcoin

Although we don’t have a strategic allocation to Bitcoin, in a world with growing geopolitical risk and rising fiscal deficits, we recognize a case for having exposure to a non-sovereign currency can be made. Historically gold has served this role. Bitcoin’s construct, however, can be attractive given that it caps the maximum number of tokens at 21 million, creating an eventual scarcity for the asset. Moreover, as more money is spent electronically having a commonly accepted digital payment could expand the broader recognition and use of Bitcoin. We would note, however, that in its current form the blockchain authentication process for Bitcoin limits its usefulness for point-of-sale transactions at stores or restaurants. The concept of Metcalfe’s Law, which states the value of a network is proportional to the square of the number of participants, supports an argument for Bitcoin having value should there be a broader use case. 

We acknowledge these favorable considerations when assessing the attractiveness of Bitcoin and have weighed them in our assessment. However, at this time the speculative aspects of the asset reinforce our perspective that Bitcoin is not a suitable piece of a long-term strategic allocation. 

Bitcoin ETFs – Things to think about

The approval of the Bitcoin ETF does offer some positives for investors that want exposure to the cryptocurrency. For starters, transacting in Bitcoin is decentralized. Pricing can vary by exchange. Moreover, as a newer market, exchanges don’t have the same level of regulation as stocks, bonds and derivatives. Therefore, cryptocurrency exchanges may not have the same risk controls and safeguards around transactions. The fraud at FTX, a mere 14 months ago, serves as a fresh reminder of the infancy of the industry and how relaxed controls and oversight can harm investors. Now that there are registered and approved Bitcoin ETFs that transact in the cryptocurrency, we are hopeful that it will bring more structure and oversight for those investors looking to access Bitcoin through ETFs. 

Investors in Bitcoin ETFs should be cognizant of operational considerations such as whether the ETF owns physical Bitcoin or derivatives, what exchange(s) will be used to purchase the cryptocurrency, how the private keys will be stored and who will have access to them, and the fees paid on the investment vehicle.  

Consistent with our approach to reviewing all investments, we believe an understanding of the investment structure, the underlying risks, and the role it plays in a portfolio are critical considerations for investors. 

ⁱHarvey, C., Zeid, T., Draaisma, T., Luk, M., Neville, H., Rzym, A., Van Hemert, O. (2022) An Investor’s Guide to Crypto.

All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Telemus Capital cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. Kovitz Investment Group Partners, LLC (“Kovitz”) DBA Telemus Capital. Telemus Capital is a division of Kovitz, a registered investment adviser with the Securities and Exchange Commission (SEC). Telemus Capital’s main office is located in Southfield, Michigan. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. Current and future portfolio holdings are subject to risk. Risks may include interest-rate risk, market risk, inflation risk, deflation risk, currency risk, reinvestment risk, business risk, liquidity risk, financial risk, and cybersecurity risk. These risks are more fully described in Telemus Capital's Firm Brochure (Part 2A of Form ADV), which is available upon request. Telemus Capital does not guarantee the results of any investments. Investment, insurance, and annuity products are not FDIC insured, are not bank guaranteed, and may lose value. Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. The S&P 500 index includes 500 leading companies in the US and is widely regarded as the best single gauge of large-cap US equities.

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