How to Spot Hidden Crypto Stocks and Funds in Your Portfolio

Ivanna Hampton: The cryptocurrency market experiences highs and lows. Investors don’t need to buy digital assets like coins to have exposure. The stocks and funds in their portfolios may have links to the crypto industry. Morningstar Research Services’ quantitative analyst Manan Agarwal has researched obvious and hidden crypto exposures.

What Makes Digital Assets Different From Traditional Assets?

Manan, what makes digital assets different from traditional assets like stocks and funds?

Manan Agarwal: Well, digital assets like cryptocurrencies, they really are an emerging asset class that have only evolved over the last decade or so. They have recently reached the $1 trillion market cap. The growth that this asset class has seen has been phenomenal and unlike any other asset class really. Of course they do differ from traditional assets in a number of key aspects, for example, while traditional assets really rely on intermediaries and centralized platforms, digital assets, by their very definition, are decentralized. Not just that, digital assets also offer direct ownership, greater accessibility, and greater transparency when compared to these traditional assets. Now having said that, digital assets are also host to extremely high volatility when compared to traditional assets, and they are by no means an investment suitable for all investors. Investors should, I think, really have a word with their financial advisors before they jump into the crypto space.

Unintended Cryptocurrency Exposures

Hampton: So, you researched intended and unintended crypto exposures. Can you explain what you found?

Agarwal: I think the most important finding of that piece of research was that there do exist a host of ETFs and equity funds that do not really market themselves as being exposed to crypto. But when you really jump into the holdings, you see that there’s a lot of stocks that they hold which directly or indirectly are exposed to the crypto space. So we really defined intentionality by the intention of the fund itself to invest in the crypto space or the digital asset space. If a fund does not mention that it’s going to invest in digital assets either in its fund documents or in its name and is still exposed to digital assets, we say that such a fund is unintentionally exposed to digital assets. We found that while a lot of intentionally exposed funds are domiciled out of the United States, a lot of unintentional funds, on the other hand, are domiciled from across the globe from countries in the Americas, Asia, as well as Europe.

Now investing in stocks and funds with these unintended exposures might put an investor’s portfolio at risks that are unwanted and unforeseen. And investors should really scrutinize their investments and their holdings before they really jump into investing into these funds.

Companies With Crypto Exposure

Hampton: Can you name a few companies that explicitly work in this space and have crypto exposure?

Agarwal: We have classified all the companies that are exposed to the digital asset space into six broad categories. These categories are technology providers, fintech solutions, payment platforms, mining, hardware, and asset owners. Overall, we have identified 77 stocks that we believe are exposed to the crypto space. On top of the list, we have companies that work explicitly in the crypto space; these include companies like Block, Coinbase Global, Galaxy Digital Holdings, Marathon Holdings, Bitfarms, Riot Platforms, and the likes. Of course, this list is not exhaustive, but these are some companies just off the top.

Hampton: Now, what about companies that are involved in other ways, like payment processing or creating hardware or tech? Who are they?

Agarwal: Well, like I said, we have divided the entire universe into six categories. Technology providers are companies that are working to enable the crypto space, the adoption of cryptos in general. These are companies like Alphabet and Baidu. Next, we have fintech companies like Coinbase Global and Galaxy Holdings. These are companies that provide services in the crypto sector. Then we have payment platforms; payment platforms are companies that enable businesses to essentially accept crypto payments or transact in cryptos. These are companies like PayPal, Visa, Mastercard, and so on. Then we also have some mining companies. Mining companies are the ones that actually solve complex computational problems to come up with new cryptocurrency coins. These are aided by companies like Samsung and Taiwan Semiconductors that help develop the hardware that these companies need. And finally, we have some asset owners that hold crypto on their investment portfolios or on their balance sheets. These are companies like Tesla and MicroStrategy. All of these companies enable the digital asset space in one way or another. And you’ll also notice that almost all of these companies are either from the technology sector or from the financial-services sector.

Bitcoin’s Extreme Volatility

Hampton: Now, bitcoin and other digital assets have experienced extreme volatility. How have the stocks with crypto exposure performed during those times?

Agarwal: Well, quite similarly. In 2022, for example, the stock basket that was exposed to crypto, it experienced a return of negative 40%; bitcoin during 2022 fell by roughly 60%. At the same time, the broad equity markets they fell by just 20%. Even in terms of volatility while the broad global equity markets they experienced volatility of just under 20%. The crypto basket, the stock basket it experienced the volatility of over 30%. There’s quite a lot of volatility and lower returns when you look at the crypto basket stocks when compared to the equity space in general. One thing that’s important to note here is that stocks are often subject to constraints on how much they can rise or fall on any given day, while cryptos are not. So movements as extreme as those seen in the crypto markets are not really that common in the equity space, right? But having said that, since 2019, there has been a correlation of over 70% between the returns of the crypto space and the stocks that are exposed to digital assets. That essentially means that while the magnitude of returns might not be comparable, the direction is the same 70% of the time.

How Do Funds Invest in Cryptocurrency?

Hampton: And some funds make it clear that they’re investing in crypto because it’s in their name. How do other funds find themselves investing in the space?

Agarwal: So firstly, I think it’s worth noting that most of these funds are from the universe of thematic funds. Our analysis suggests that funds that track themes like AI, big data, metaverse, cloud computing. One way or another, they find themselves unintentionally exposed to the digital asset space. And it’s not a small part of their portfolios; sometimes this can be as high as 75%. Of course, some of this exposure might come from these companies also investing in big tech companies like Meta, Amazon, Netflix, and the likes. But even outside the big tech, we find that these funds can often hold a majority of their portfolio in the crypto space. A very prominent example for that is the Global Metaverse ETF, the Horizons Global Metaverse ETF, which holds almost 45% of its portfolio in crypto-exposed companies, and that’s outside the big tech companies.

Bank Collapse Ripple Effects

Hampton: FTX, Luna, and Signature Bank collapse—what ripple effects came from their downfall?

Agarwal: When cryptocurrency market was on the upswing, a lot of these publicly traded companies, they started offering cryptocurrency-enabled services like crypto mining, transaction payment platforms, financial technology solutions, and some of them even started holding cryptocurrencies on their portfolios. However, with the crypto downfall of 2022, companies with these tangential exposure, they really witnessed domino effect of the falling crypto markets. Prominent examples, of course, include the closure of Signature Bank, the bankruptcy of Core Scientific, and then of course, the collapse of FTX, Luna, and the like. So of course there has been a ripple effect and like some of these effects include, but are not limited to, the loss of confidence in the market in general, an increase in regulations for the crypto market. Then there also is increased scrutiny of stablecoins and all coins in general. And finally also a loss of jobs, right there has been massive job cuts because of the downfall of these companies. I think while it’s still early to think about the long-term effects of these events, they have clearly had a significant impact on the market and have raised serious doubts over the future of cryptocurrencies as well.

Bitcoin and Altcoins During Bull and Bear Markets

Hampton: What have you found when it comes to nitcoin and altcoins during bull and bear markets?

Agarwal: We found that during bull markets, altcoins tend to outperform bitcoin in general. That is because during bull markets, the investor sentiment is generally very high. Investors have a very positive outlook for growth of the cryptocurrency market. So they tend to get less risk-averse, right, more risk-seeking. They tend to gravitate toward riskier investments, smaller coins, which essentially are altcoins, and away from bitcoin. So that leads to underperformance of bitcoin during bull markets. But again during bear markets, the investor sentiment reverses again and investors again shift back toward the safe havens of crypto, which is essentially bitcoin and ethereum. I also think that altcoin, the launch of altcoins in itself, is a bull market phenomena exclusively compared with bitcoin and ethereum, altcoins of course have the added risk of failure and liquidity. And these past few years have in fact seen significant failures pertaining to such altcoins. Prominent examples are BitConnect and (indiscernible), their failure in 2018, and then OneCoin in 2019. All these coins were launched with a lot of promise and with a lot of enthusiasm during the bull markets. But when the crypto winter came, all of them turned out to be Ponzi schemes.

Is Crypto a Hedge Against Stocks and Inflation?

Hampton: Now, some investors believe crypto is a hedge against stocks. Tell us why that may not be the case.

Agarwal: Some investors do believe that crypto can offer a hedge against stocks. That is, they can help protect the investors’ portfolio when the stock market returns turn negative. However, we found no evidence to support that claim. In fact, studies have found that cryptocurrencies are in fact more correlated with the equity markets than with other asset classes like gold. This essentially means when the stock market declines, cryptocurrency markets decline as well. Also, most of these cryptocurrencies, they haven’t been around for that long. Since the second half of 2021, in fact, these coins have not offered any hedge against the stock market whatsoever. That, coupled with the high volatility that we experienced with crypto coins and the regulatory uncertainties, I think that seriously casts a doubt on their efficacy as a hedge against these stocks.

Hampton: Now, what about serving as an inflation hedge?

Agarwal: Despite the volatility, some investors do believe that cryptocurrencies can offer a hedge against inflation. However, our research did not find any observable evidence to support that claim. We checked the correlation between the digital assets and the U.S. core CPI inflation. We found that while the correlation was positive until the first half of 2021, since 2022 the correlation has turned negative, and if looked at for a longer—from a long time perspective, long horizon perspective—cryptocurrencies really do not offer any hedge against inflation either.

How Do Investors Uncover Hidden Crypto Exposure?

Hampton: Now, if investors want to do some digging in their own portfolios, how would they uncover potential hidden crypto exposure?

Agarwal: I think firstly it’s important that the investors dive deeper into the holdings of their equity funds and ETFs that they hold, especially if they are heavily invested in the technology or financial-services sector. Thematic tags and funds that follow the thematic spaces in general—that can serve as a red flag as well, as far as uncovering hidden crypto exposures is concerned. Due to its very nature, only reading through the fund documentation might not always be enough, especially when it comes to weeding out the unintended crypto exposures. I think investors should consult with their advisors on the best way to identify these companies. They must understand the full extent of their exposure to cryptos at an asset-class level. So investors often believe that they do not have crypto coins in their portfolios, so they’re not exposed to cryptocurrencies, but they might be, so it really helps to have some thorough due diligence when building their portfolios.

Where Should Investors Invest?

Hampton: Now if they want to intentionally invest in crypto, what are some recommendations?

Agarwal: A very direct way to invest in cryptocurrencies would be through investing in crypto coins themselves—bitcoin and all. However, that can sometimes present a host of challenges, ranging from regulatory to liquidity concerns, even legality and taxations are often very uncertain. Investing in cryptocurrencies through equity route can offer a resolution for some of those challenges. If an investor does not want to invest in cryptocurrencies directly and wants to invest through equities, there’s a couple of ways. First is to invest in crypto-based exchange-traded products, or ETPs. These ETPs are essentially like ETFs, and they trade on the exchange, but instead of stocks and funds, these ETPs essentially hold cryptocurrencies in their portfolio. The second way is to invest in equity stocks and equity mutual funds with established exposure to the crypto space.

Of course, both these approaches have their own benefits. If an investor decides to go through the ETP route, some top names include the likes of Grayscale Bitcoin Trust. Then we have the ProShares Bitcoin Strategy ETF. We also have the 21Shares Bitcoin Core ETP. ETPs like 21Shares Short Bitcoin ETP also allows investors to take a short position on cryptocurrencies if needed. If, on the other hand, the investor decides to take exposure through equity, they can do so by identifying stocks and funds with high crypto exposure. Some funds with high intentional exposures here are Global X Blockchain ETF, BetaShares Crypto Innovators ETF, the VanEck Digital Transformation ETF, the VanEck Crypto and Blockchain ETF, and so on. I mean, the list is large, and the names I said are by no means exhaustive, and investors can find the full list in the Morningstar research report that we’ve published.

Hampton: Thanks, Manan, for explaining how crypto can hide in plain sight today.

Agarwal: Thank you for having me.

Hampton: Thanks for tuning into Investing Insights. I’m thanking lead technical producer, Scott Halver, craft editor and cinematographer David Ettinger, and senior video producer, Jake Vankersen. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say “Play Morningstar.” I’m Ivanna Hampton, your host, and a senior multimedia editor at Morningstar. Take care.

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