Matt Hougan started as a freelance writer for IndexUniverse (now ETF.com) in 2006 and worked his way up to CEO. He joined Informa after that company bought ETF.com's events division, powering the largest ETF conference on the planet, Inside ETFs. Now he's working as global head of research at Bitwise Asset Management, creator of the world's first cryptocurrency index fund. InvestmentNews senior columnist John Waggoner spoke with Mr. Hougan this week to talk about the leap from ETFs to cryptocurrency.
John Waggoner: This seems like an awfully big change from the ETF world.
Matt Hougan: It is a big change, but it rhymes with my history. There are a lot of analogs with my ETF journey. Though I've gone from working with hundreds of people at Informa to a staff of seven folks here in San Francisco.
JW: Tell me about the fund.
MH: It's a limited partnership. Our index and our fund track the 10 largest cryptocurrencies by their inflation-adjusted market cap. And we base that on their size five years from now, because most cryptocurrencies work on a planned issuance pattern. The index captures about 80% of the market cap.
The industry has a massively long tail, given the number of smaller coins. Those are subject to manipulation, they're illiquid, and difficult to trade. It's a little like the early days of emerging markets, when the major indexes excluded small-cap stocks because they were illiquid and hard to trade. Cryptocurrency is an emerging frontier-stock kind of asset class, with a huge variation in returns. People who buy bitcoin alone are crazy. It's like buying Apple and calling that your equity portfolio. Our goal as a business is to make it easy and convenient to buy and sell, and, in the world of crypto, cheap.
The fund charges 2.5% in annual fees, which is a lot, but way less than a two and twenty hedge fund charges. Custody costs are extreme. It's like storing gold, but a bit more difficult. Crypto is basically a bearer instrument, so you need computers that have never been connected to the internet and multi-signature protocols. I can't wait for more custodians to come into the space.
JW: Who can invest in it?
MH: It's for accredited investors, and those registered under the Securities Act of 1933 with a JOBS Act exemption. We have to verify each investor. The burden is on us to make sure it's appropriate for them, because it's the early stages of a risk market.
JW: Do you think we'll ever see a bitcoin ETF?
MH: Eventually, I'm certain we will. When that time comes, it will be a good thing for investors. Pricing is a real issue. There is no agreed-upon cost for bitcoin and Etherium and the price variations on different exchanges can be significant. We use volume-weighted prices from multiple exchanges and screen for erroneous prices — these are young data streams. Pricing disparities are less significant in bitcoin, but as you move down the sector, to Eos and really to more obscure coins, pricing and consistency of pricing is something you have to think about. A fund needs to be rules-based, trustworthy and verified.
JW: How is your fund doing?
MH: The fund launched on November 22, and through March 28 it's up 3.3%. By comparison, bitcoin is down 3.7%. On a back-tested basis, and with all the caveats that come with that, the entire 10 cryptocurrencies are up 771% the past 12 months, while bitcoin is up 659%. And in the last 12 months, the average difference between the top-performing and worst of the 10 largest cryptocurrencies was 300 percentage points on any given month. It makes the case for the value of diversification.
JW: Don't those big fluctuations in price kind of make it difficult to argue that they're useful as a currency?
MH: Some of the coins are designed as currency, while others have other uses. But as cryptocurrencies mature, the volatility comes down. If you go back to 2013, 50% daily moves were not uncommon. As you see volatility go down, you'd expect return levels to come down. In early, early stage venture capital, you don't expect the risk because it's not marked to market daily. The early venture capitalists in ETF.com had the same crazy volatility, but they didn't see it in the early stages of investment.
JW: Who should invest in crypto?
MH: Crypto is one of those low-correlated assets, and it has a low correlation to stocks, bonds, commodities and volatility. It's a risk asset, so its correlation to volatility is higher than it is to the other three. It's an idiosyncratic asset stream that can be valuable. Unless it's regularly rebalanced, allocations can get out of whack: If you put in a 2% of rebalancing rule, at least over the last three years, you would have substantially increased returns.
Cryptocurrencies should be approached with caution. It's not something for 50% of your retirement portfolio. It should be in the single digits and for the risk tolerant.