Fund firms eye risk-managed ETFs for cautious bitcoin investors

As bitcoin's wild rally puts it well on the path to a $100,000 valuation,  a group of asset managers are looking to launch strategies to allay fears among investors who may be concerned about the mainstay cryptocurrency's potentially wealth-destroying volatility.

The investment firms, which include crypto fund pioneer Grayscale Investments and First Trust, a known leader in the buffer ETF space, are seeking regulatory approval to launch bitcoin ETFs that are designed to limit losses, offering a potential entry point for investors cautious about cryptocurrency volatility.

As reported by the Financial Times, the proposed ETFs employ strategies like options and derivatives to reduce downside risks, potentially at the cost of capping gains.

“Given the meteoric rise in bitcoin this year, many investors are likely regretting they missed out because they were nervous about the volatility of the cryptocurrency,” Todd Rosenbluth, head of research at TMX VettaFi told the Times. “These pending downside protection ETFs will allow more people to add bitcoin exposure to their portfolios in a risk-aware manner.”

The filings come following the landmark SEC decision in October giving its approval to allow options trading on some spot bitcoin ETFs. Options allow for risk-reducing strategies, such as buffer and managed floor ETFs, which offer partial loss protection in exchange for limiting potential gains. Morningstar data indicates buffer ETFs, a similar concept, have surged in popularity, growing from negligible assets in 2019 to $47 billion this year.

Several firms have outlined distinct approaches in their filings. Calamos Investments is pursuing four managed floor ETFs, while First Trust Portfolios has proposed both a 15 percent floor ETF and another protecting against the first 30 percent of losses. Innovator ETFs is seeking approval for a 10 percent buffer product with a three-month operational period, and another three-month, 20 percent managed floor ETF.

“If people are going to allocate 1-2 percent [of their portfolio to bitcoin], they don’t necessarily want to be capped,” Graham Day, chief investment officer at Innovator ETFs told the Times. “They are in it because if bitcoin goes up 300 percent, they need to keep most of it in order for bitcoin to have a meaningful impact on their portfolio.”

Grayscale Investments, meanwhile, has filed for a covered call bitcoin ETF, which would generate income through options while limiting potential price appreciation.

Despite their appeal, the new ETFs face limitations, including position caps on options contracts for individual spot bitcoin ETFs. If the ETFs catch on among retail investors, that could prove a problem especially as asset managers won't have the option to keep new investors out.

However, firms remain optimistic about capacity expansions and rising demand.

“The options market is in its infancy,” said Day, who argued creating safety nets against losses could help make bitcoin attractive to advisors who remain wary of the asset class.

While acknowledging the arrival of the new risk-managed ETFs as an "inevitable" example of innovation in a popular asset class, Kenneth Lamont, senior fund analyst at Morningstar, expressed skepticism about their broad utility.

“If you are not willing to take on the risk/return characteristics of the asset class maybe you shouldn’t be exposed to it?” he said.

If the firms get the SEC's blessing, the new ETFs could begin trading as early as February.