By Aaron Brown
(Bloomberg Prophets) --Are cryptocurrencies an asset class? That depends on you. When you choose an investment portfolio, do you want to start with a category for these new currencies along with stocks, bonds and money market instruments?
This is not related to the question of whether or how much you should invest. You can call cryptocurrencies an asset class and assign zero or even negative portfolio weight to them. Or you can decide they're not an asset class and still try to get positive or negative exposure to them via other asset classes.
There are two main reasons to have asset classes.
The first is that different classes have different uses. Stocks are used primarily for growth, bonds primarily for income and money-market instruments primarily for liquidity. For most investors, it makes sense to set portfolio-level targets for growth, income and liquidity before making individual asset decisions.
Some investors go beyond the big three classes. A popular addition is real assets -- including real estate, commodities and inflation-protected bonds -- to set portfolio-level inflation protection targets. Some investors add credit. But it's equally rational to decide to get real asset exposure via hard-asset stocks and credit exposure in bonds. Calling something an asset class doesn't change how much you invest in it, it changes how you allocate funds and track performance.
Do cryptocurrencies have a different use than traditional financial assets, meaning that investing in them is a portfolio-level decision? The answer is clearly "yes" for technophiles who participate in cryptocurrency development and use them for transactions. The answer is clearly "no" for people who buy them because the price has gone up recently, in the hopes of selling them when the price rises more; also for people who are buying them for pure inflation protection.
The rest of us have to decide if cryptocurrencies will support a nontraditional business sector that blurs the lines among investors, employees and customers; or if ideas like distributed ledgers are going to be incorporated into traditional businesses funded by stocks and bonds. Again, the question is not what you think about the likely level of success of cryptocurrencies and related technologies, but whether you think the value, if any, will be captured by traditional companies or holders of cryptoassets. You don't have to know for sure. If you think there is a significant probability that a significant slice of future economic value will be represented by cryptoassets, it makes sense to think about your portfolio-level exposure to that event.
The second reason to have asset classes is that it's hard to compare different types of assets, like a stock with a bond. Once you decide on an allocation to an asset class, you can look over all the assets in that class, and select the best combination for your goals. If the only thing you care about with a cryptocurrency is its price history, then it's in with equities. If you plan to read whitepapers, interview developers, test code and model issuance, then cryptocurrencies need their own category, because that's nothing like stock or bond research.
That leaves a middle group of investors who care about cryptocurrency fundamentals, but plan to delegate the research either to managers in an active fund or to the market in an index fund. Here the choice is how you plan to evaluate investments. If you're going to use traditional metrics such as alpha and Sharpe ratio, then these funds are equities. You use them to the extent they improve the risk-return ratio of your equity allocation.
On the other hand, if you think the manager's job is not to make profits in dollar terms, but to make your cryptocurrency grow in cryptocurrency terms, then they need their own asset class. Is your plan to sell your cryptocurrency fund when you retire, for cash to support your retirement? Or is it to use the cryptocurrency represented by your fund to support your retirement directly?
Don't let know-it-alls tell you that you either have to or can't treat cryptocurrencies as an asset class. That decision has nothing to do with correlations or trading volume, market cap or projected returns, governance or regulation. It's about how you plan for the future. If you view cryptocurrencies as a potential way to increase your traditional wealth, then they belong in traditional asset classes. If you regard them as connections to a new type of wealth, then they need their own class.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Aaron Brown is a former Managing Director and Head of Financial Market Research at AQR Capital Management. He is the author of "The Poker Face of Wall Street."
To contact the author of this story: Aaron Brown at [email protected] contact the editor responsible for this story: Max Berley at [email protected]
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