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Are Cryptocurrencies Lurking in Your Funds?

Here's who has dipped into the crypto pool.

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Cryptocurrencies like bitcoin have been making headlines, but have they been making their way into fund portfolios? Joining me today to discuss that topic is Russ Kinnel. Russ is Morningstar's director of manager research and editor of Morningstar FundInvestor. Hi Russ, thanks for being here today.

Russ Kinnel: Glad to be here.

Dziubinski: How common are cryptocurrencies in fund portfolios today, and do you expect to see sort of an uptake in cryptocurrency plays in 2021?

Kinnel: It's interesting. At this point, you don't to see any direct cryptocurrency ownership by mutual funds because of the challenges of liquidity. A mutual fund is a daily liquidity vehicle, and so to put something where you clearly cannot sell and turn that quickly into cash into a '40 Act fund is a problem. What we see instead is indirect ownership, and I think that's only going to increase. So, there are various plays that you can own in lieu of actual cryptocurrency, and I think that's certainly going to grow.

Dziubinski: And what are some of those plays, some of the ways that funds are getting exposure to crypto?

Kinnel: There are things like Grayscale Trust is one, and there are some other indirect plays, various stocks that might have some play. Obviously, even Tesla is indirectly a little bit of bitcoin right now. They own some bitcoin. And you can see that some funds clearly are buying some of these names for the indirect bitcoin play, even if it's not the majority of the company's business.

Dziubinski: Let's talk a little bit about some of the bigger names that maybe have dipped a toe in some way in the crypto pool. Let's start with Morgan Stanley Institutional Growth. That's a fund that has been playing around a little bit in that pool, right?

Kinnel: That's right. They filed and are considering adding a small bit of exposure via Grayscale. And it's interesting because Dennis Lynch's fund had massive returns last year, so it's one of the few funds that really doesn't need to hype itself up with bitcoin, but they view it as a hedge. They kind of think of it as a updated version of gold as a hedge, but I think it's clear that they want to keep it very small. They're talking about 2% or less of the portfolio, which I think is important because obviously if you add a really volatile security to your portfolio, that can dominate the portfolio, even if it's only, say, 10% or 20% of the portfolio. At 2%, you figure, well, it's really not going to have a dramatic impact.

Dziubinski: And what are some other examples of funds that have either filed, added this to their prospectus that they are able to do this, or funds that are actively engaged in investing in crypto indirectly?

Kinnel: I'm really interested in Emerald Banking and Finance because they didn't change their prospectus, but now they're 23% crypto plays, including private placement that gives you crypto exposure. They've got Grayscale. They've got a wide array of bitcoin. And if you look at their top 10 holdings, you see gains from ... they're all up more than 100%, some up more than 10,000%. So, even though it's 23% of the portfolio, really the tail is wagging the dog, and if you think about someone who might've bought the fund for regional bank exposure, I don't know if they want this big crypto play. Obviously so far it's been great because crypto has been doing really well, but it's really interesting to see a fund like that. Whereas others have very tepidly taken the steps to filing or filed to have some exposure, this is one that hasn't even changed its filing but has just jumped right in.

Dziubinski: Wow. So, what are the risks here, Russ? I mean, obviously it's adding volatility to a portfolio. What are things investors need to be thinking about with this in their funds?

Kinnel: I think obviously crypto is a very unpredictable type of security. It's new and, to a fair degree, a little like gold: Its value is whatever people perceive it to be. It's not throwing off income like a company or a bond. So, I think it's very volatile. And then on top of that, of course, any of these indirect plays have already gone up a ton so, defacto, you're paying a big premium for these more liquid indirect plays. So I think there's a fair amount of risk, and I think obviously we're just in an unknown area.

Dziubinski: Let's touch briefly on Coinbase, which is a platform for trading cryptocurrencies that recently went public. What do you think the uptake is going to be among fund managers with that particular stock as a crypto play?

Kinnel: I think it's going to be huge. Now you have a very liquid play that's a direct play on crypto. And so I think you're going to see a lot of growth funds invest in Coinbase. If you think about it, growth managers like to be part of any big trend. They want exposure, and really there's been very little ways to get bitcoin exposure or any kind of crypto. Now there's a huge way that's very liquid. I expect to see a lot of growth portfolios from a lot of the big fund companies own it as we start to see portfolios from after this date.

Dziubinski: As funds over time start to get more exposure perhaps to cryptocurrencies, do you think this is going to have any effect on our fund Analyst Ratings for these types of funds?

Kinnel: We already downgraded Emerald because of its big bet, which I think is outsize. Beyond that, it's kind of hard to predict. I don't think necessarily if, say, we see a growth fund with 2% in Coinbase, I don't think that necessarily implies a change in the rating. And again, it's not that we're predicting the direction of crypto--it's simply we recognize that there is some liquidity and volatility challenges when you buy, particularly outside of Coinbase, I think, there's some real risks there. So, it's a little hard to predict, but I'm certain that we're going to see more and more crypto exposure in mutual funds.

Dziubinski: Well, Russ, thank you for your time today. I think this is a story that you and I will be talking about quite a bit over the course of the next year. Appreciate your time.

Kinnel: You're welcome.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.