Financial advisors have been fielding many questions from clients about cryptocurrencies such as Bitcoin and Ethereum in recent years as these alternative assets have soared in value, retreated and then climbed again.
Yet, investors’ dreams that one of these cryptocurrencies will become the new digital gold misses the big picture. That’s because the true growth opportunity isn’t in the cryptocurrencies themselves, but in the technology underpinning them: blockchain.
“In the past four or five years, we’ve seen incredible growth in blockchain’s use and adoption by mainstream companies and industries,” says Kushal Agarwal, chartered financial analyst and investment associate at Harvest Portfolios Group Inc.
Blockchain started off with Bitcoin because it was the first application built on the technology, says Mr. Agarwal, who specializes in tracking the technology subsector.
He explains that blockchain is essentially a decentralized or distributed ledger, in which blocks or nodes are connected. Everyone participating in the network can see what’s being transmitted. That makes blockchain very secure, accurate and tamper-proof. Its potential utility is creating a seismic change across many industries, from finance and insurance, to logistics and manufacturing.
Mr. Agarwal points to International Business Machines Corp. IBM-N and Visa Inc. V-N as key examples of multinational firms making major investments in blockchain. Harvest has also been a pioneer in this respect, seeing blockchain’s potential and launching Blockchain Technologies ETF HBLK-T in early 2018.
“We’ve designed an index-type product that evolves [along] with blockchain’s impact on industries,” he says.
So far, so good: the exchange-traded fund (ETF) posted an increase of more than 150 per cent in 2020 alone.
Driving that performance are companies wholly involved in the technology, like the cryptocurrency trading app Voyager Digital Ltd. VYGR-CN, as well as large-cap technology or financial firms like Square Inc. SQ-N and Intel Corp. INTC-Q.
For much of the past decade, blockchain technology has been synonymous with cryptocurrency – not for investors who are faint of heart. Now, blockchain is providing potential for significant growth, but without some of the downside risks that were first apparent in its nascency.
Finding a spot in growth portfolios
Given blockchain’s growing importance, many advisors are paying closer attention to it as a viable investment theme, deserving a spot in growth portfolios.
“Cryptocurrencies may be the poster child for blockchain, but where the rubber hits the road is when blockchain gets a lot more boring in its potential to improve efficiencies for a lot of sleepier industries,” says Grant White, a portfolio manager with Endeavour Wealth Management at Industrial Alliance Securities Inc. in Winnipeg.
Many companies that are focused exclusively on blockchain are new, with uncertain paths. Adam Hennick, investment advisor with Hennick Wealth Management at Research Capital Corp. in Toronto, sees some parallels between blockchain and an emerging technology from two decades ago.
“In 1999, I did research and found all these amazing applications for Bluetooth,” he says. “The basis for investing in companies developing the technology back then was that everything would be without wires.”
Mr. Hennick created a small portfolio of promising Bluetooth-related companies. Fast forward to today, and Bluetooth is ubiquitous. Yet, only one company in that portfolio is still around. “The rest went to zero,” he says.
Advisors face a similar challenge today investing in blockchain. “That’s why I would focus on the big players like IBM, which is well positioned to be a service provider to companies that need blockchain,” Mr. White says.
One downside of this strategy is that investors may miss out on rapid growth, fuelled by the success of smaller firms involved solely in blockchain technology. Those include cryptocurrency miners and creators of applications helping other industries adopt the technology.
Still, Mr. White says there’s an advantage to investing only in large-cap companies with limited exposure to blockchain.
“Are you going to get the high-flying 1,000-per-cent return [with that approach]? No, but you’re not going to get those high-flying companies that ultimately fail either,” he says.
ETFs may be a better bet
Given the risks trying to pick winners, Mr. Hennick suggests that ETFs are a better option for clients seeking blockchain exposure in their portfolio.
“But then,” he says, “you have to check out the managers to make sure they have exceptional knowledge about the technology and involved companies.”
Harvest’s Blockchain Technologies ETF bears closer examination in this respect, offering diversification across 46 companies. The holdings straddle large-cap companies like Infosys Ltd. INFY-N and Microsoft Corp. MSFT-Q, and up-and-comers like Nuvei Corp. NVEI-T (a business-to-business payment firm) and Riot Blockchain Inc. RIOT-Q (an established cryptocurrency miner).
Harvest’s ETF index is reconstituted quarterly. Its managers scrutinize a universe of over 200 companies, with the aim of increasing exposure to more pure-play blockchain firms gradually.
“As more dedicated companies come out with real-world use cases, the index is systematically designed to increase allocation to those firms,” Mr. Agarwal says.
As that happens, exposure to large-cap holdings is reduced proportionately. The strategy has proven successful to date.
“Until recently, it was the top-performing ETF in Canada for one-year performance, and it’s still in the top 10,” Mr. Agarwal says.
While the ETF’s future performance is anything but guaranteed, Mr. Agarwal says it’s likely a less risky alternative to investing in Bitcoin. Unlike cryptocurrency, which has a more uncertain future, blockchain as a technology is likely here to stay.
“This is an exciting area with immense growth potential,” Mr. Agarwal says. “Any investor interested in blockchain should consider allocating a small percentage of the portfolio to it.”