Risk-averse investing in cryptocurrency might sound like a contradiction in terms, but a tranche of US exchange trade fund providers have plans to let investors try to do just that.
A quartet of asset managers have filed with US regulators to create ETFs that invest in bitcoin, but use derivatives to minimise or completely protect against potential losses.
“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,” said Todd Rosenbluth, head of research at TMX VettaFi, a consultancy. “These pending downside protection ETFs will allow more people to add bitcoin exposure to their portfolios in a risk-aware manner.”
The flurry of filings was triggered by the listing of options contracts earlier this month on some of the spot “physical” bitcoin ETFs that were launched in the US in January and now hold about $100bn of assets.
The arrival of listed options allows ETF providers to bring bitcoin into the ambit of both buffered/managed floor and covered call strategies, two highly popular concepts that utilise derivatives to lessen investors’ risk, in return for them surrendering some potential gains.
The filings offer a potential smorgasbord of choices for those keen to dip their toes into the crypto waters in a measured way.
Some are buffer ETFs (see explainer box below), a format that has exploded in popularity in recent years, surging from next to nothing in 2019 to $47bn in assets, according to Morningstar.
Calamos Investments has filed for four managed floor ETFs (see box below).
First Trust Portfolios has filed for a 15 per cent floor ETF as well as a buffer ETF designed to protect against the first 30 per cent of any loss.
Innovator ETFs is angling for a 10 per cent buffer product that would operate over a three-month period. In another twist, it has also filed for a 20 per cent three-month managed floor ETF with a “participation rate” (see box below).
“If people are going to allocate 1-2 per cent [of their portfolio to bitcoin] they don’t necessarily want to be capped. They are in it because if bitcoin goes up 300 per cent they need to keep most of it in order for bitcoin to have a meaningful impact on their portfolio,” said Graham Day, chief investment officer of Innovator ETFs.
Day believed bitcoin would be more attractive to advisers if the risk of extreme losses could be erased.
“If you look at quarters when bitcoin is down the losses can be pretty extensive — 50,60,70 per cent. Investment advisers have been looking for a way to make bitcoin more investable for their clients. This can give them a smoother ride so that they can allocate more,” said Day, whose firm has also filed for risk-on leveraged and inverse bitcoin ETFs.
Rounding out the filings, Grayscale Investments plans to launch a covered call bitcoin ETF, which would sell call options on spot bitcoin ETFs. This would reduce the potential price gains if bitcoin rises, but provide a regular stream of premium income instead.
One complication for all of the filings is that there are position limits of 25,000 contracts in place for the options of each of the underlying spot bitcoin ETFs. Given the current $55 price of the iShares Bitcoin Trust ETF (IBIT), for example, this would mean no managed risk ETF can hold more than $137.5mn worth of options in IBIT.
As ETFs cannot be closed to new investors, this could potentially create difficulties if they prove popular.
However, each ETF will potentially be able to hold options written on a range of underlying ETFs, while Day was confident that options on a bitcoin index created by the Chicago Board Options Exchange, with far higher position limits, will list as early as next week.
“That gives us significantly more capacity to structure these products,” said Day, who added that he would expect to see the position limits raised if demand was strong. “The options market is in its infancy”.
Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, viewed the development of risk-managed bitcoin ETFs as “inevitable”.
“The financial industry will do what the financial industry does. It will overcomplicate things as much as the market will bear,” he said. “It’s just a logical step when you have a new, very popular asset class.”
Lamont believed there may be niche uses for such products, but was unconvinced they should command widespread uptake.
“If you are not willing to take on the risk/return characteristics of the asset class maybe you shouldn’t be exposed to it? Or just buy less of it,” he said.
“There is a large potential upside [to crypto]. You want exposure to that, so why are you paying for this to damp the upside?”
However, Rosenbluth was more upbeat. “These funds will not appeal to the risk-on crowd any more than other buffered or structured protection ETFs but they can fit into many portfolios. There are likely a lot of people that have zero exposure to bitcoin and are worried that they missed their chance,” he said.
If approved by the Securities and Exchange Commission, the ETFs could list in February.
A quick tour of some of the proposed risk limitation ideas
Buffer ETFs buy options that provide an initial downside protection layer, say 15 per cent, that shields an investor from a loss of up to this level in a given period, for example a year. Investors are on the hook for losses beyond this point. The protection is paid for by selling options that mean investors miss out on any gains above a preset cap.
Given the volatility inherent in bitcoin, some filings are a twist on this approach, known as managed floor ETFs. In this format, investors are exposed to losses up to a certain point, say 20 per cent, but are protected beyond this.
Calamos Investments has filed for four managed floor ETFs. Three would limit potential losses to 20 per cent, 10 per cent or zero over a year (before fees and expenses), with a fourth offering complete downside protection for six months. The greater the protection, the lower the potential upside gains will be.
Innovator ETFs’ 20 per cent three-month managed floor ETF, instead of a cap on potential gains, would offer a “participation rate”, under which investors would receive a preset percentage of any gain made by bitcoin during the quarter.
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