Should Public Pension Funds Be Investing In Cryptocurrency?
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Commentary

Should Public Pension Funds Be Investing In Cryptocurrency?

It’s not wise for public pension funds and taxpayers to be exposed to such financial risk.

Bitcoin’s value recently fell from its record high of $60,800 a share down to $52,800 a share, a drop of nearly 15 percent. But Bitcoin has experienced significant growth in the last year, greatly outpacing the S&P 500. With most experts predicting lower stock market returns in the near term, plus fears of inflation, and investors searching for higher yields from alternative investments, Bitcoin is increasingly becoming a larger part of many institutional portfolios, including pension funds.

Grayscale Investors, the world’s largest digital asset manager, told Bloomberg that they expect pension funds and endowments to fuel their future growth. Grayscale owns 3 percent of all shares of Bitcoin, and most of their $2 billion to $25 billion asset growth over the last year has been from Bitcoin.

Recently, the California Public Employee Retirement System (CalPERS), the nation’s largest public pension system, disclosed that it increased its investment in RIOT Blockchain Inc., a bitcoin mining company, from $49,000 in 2017 to $1.6 million in 2020.

Pension funds like CalPERS typically search for higher investment yields by investing in private equity. But in recent years, returns from private equity have underperformed in comparison to the S&P 500. Analysis of private equity returns (net of fees) has essentially matched the performance of the S&P since 2009.

The reasons for this decline are varied, but this trend can largely be attributed to the fact that private equity is a relatively mature industry in where attractive investments at low cost are hard to come by. The term “alpha” in investing refers to the amount of excess returns generated by excess risk—in essence measuring the value add of an external fund manager. In the case of private equity, alpha during the last decade was close to zero percent,  compared to hedge funds which saw an alpha of negative 1 percent.

As a result of these market trends, institutional investors have been showing an interest in even riskier assets that may produce higher yields. This search has lead public pension systems like Virginia’s Fairfax County Employees and Police Officers Retirement Systems as well as the University of Michigan’s pension plan to invest in Bitcoin and other cryptocurrencies.

While the growth in cryptocurrencies has been stratospheric in recent months, these assets have also seen massive volatility apart from the most recent price drop, with one of the largest price drops in 2018. Bitcoin had its first major peak at $20,000 per share during the end of 2017 but then plunged 75 percent in less than a year. This peak-to-trough decline is comparable to the dot-com bust, which dropped 78 percent from its peak.

The jury is still out on whether Bitcoin can hold water in the long run. Even if Bitcoin isn’t a bubble, it is likely to see a correction in the future with the flood of investors pouring in and prices will likely continue to fluctuate.

In any case, it’s not wise for public pension funds and taxpayers to be exposed to such financial risk. Public pension benefits are constitutionally protected and taxpayers—who would be asked to make up for pension shortfalls—should not be subject to the risks of such volatile investments.

Although current pension investment allocations towards Bitcoin and other crypto assets are small, California’s large increase in crypto shares could spark interest in other states. Pension funds and other asset managers may believe they can time the market and jump in on Bitcoin at the perfect time, but with something like cryptocurrencies, that is much easier said than done.

While the goal of public pension funds trying to improve yields and make up for lost growth in 2020 is admirable, Bitcoin is just too volatile at this point and the significant risks to public pension systems, retirees, and taxpayers far outweigh the benefits. A much better goal for public pension funds would be to lower their investment return assumptions and adjust other expectations to lower market yields.

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