“Blockchain [startups] are now sucking in top-tier Silicon Valley tech talent faster than any boom since the Internet.”
— Naval Ravikant, Indian-American entrepreneur and investor. He is the co-founder and former CEO of AngelList.
Blockchain-powered networks, also referred to as cryptocurrency or digital assets, are driving a revolution in wealth management, finance and payments. Startups are launching solutions for advisors to help them invest in these assets in a scalable and secure manner. For these innovative firms the incentive is clear. The cryptocurrency market is worth well over $1 trillion, and it’s not showing any signs of slowing down.
So what’s the best way to expose your clients to these lucrative new investment opportunities? One potential method is through an investment product that’s already well known in the industry, separately managed accounts (SMAs). The products, which combine the pooled experience of a mutual fund with the control and tax efficiency of individual stocks.
Assets have continued to flow into SMAs over the past decade and show no signs of slowing down. The National Association of Plan Advisors (NAPA) found that SMAs grew 34% in 2020, with advisors expecting to reduce their reliance on mutual funds in the near future. The managed accounts industry has grown to over $9 trillion, according to NAPA.
To talk about the rapid growth in SMAs, and how crypto could play a role in future growth, BitRIA CEO and co-founder Dan Eyre hosted a webinar (which you can watch on the BITRIA website) to talk about crypto SMAs.
Chris Matta, president of 3iQ Digital Assets, joined Dan in this discussion. 3iQ is Canada’s largest digital asset manager, with over CAD 2.5 billion in assets under management, and launched a Bitcoin ETF in April 2021 in both the US and Canada.
The entire webinar is two hours long, so we’ve pulled together some critical points from Dan and Chris’ discussion and split it into three parts. This first blog summarizes Dan and Chris’ talk on the differences between traditional and crypto SMAs.
Why Digital SMAs Are The Best Solution for Crypto Investing
Investing their client assets in crypto presents a challenge for advisors. “There is no S&P 500 index for this asset class that gets you broad market exposure,” Matta says. “There’s there’s a variety of different use cases and a variety of different technologies that are all bundled together.”
Matta isn’t entirely correct about this. While there isn’t a widely recognized crypto index that rivals the S&P, there are a number of companies that are vying for attention and assets for their security baskets and tracking tools.
In December 2021, asset manager WisdomTree partnered with RIA Ritholtz Wealth Management to launch a basket of digital assets that they named the RWM WisdomTree Crypto Index. The index captures approximately 64% of the total crypto market cap, according to the press release.
Of course, investors must open accounts directly with the providers of proprietary indices like RWM, which limits their reach and access.
Even with few crypto indices, advisors are still faced with a dizzying array of software tokens, exchanges, automated networks other crypto assets to choose from and their clients are beating them up for investment options.
A crypto-based separately managed account (SMA) is one of the easiest ways to provide access to digital assets for advisory clients, Matta explained.
“An SMA bundles together all the things that are great about this type of vehicle: tax loss harvesting, trading in custody, performance reporting … bundled together to make it easy for advisors to manage an allocation,” Matta said.
Since the financial infrastructure powering crypto falls outside the traditional financial system, a solution based on a program that most advisors are familiar with makes crypto SMA a logical solution.
The Benefits of Digital SMAs
Much of the rest of Eyre and Matta’s discussion centered around the potential tax benefits for HNW investors. They incur a sizeable tax liability due to their success, which they’d like to find ways to offset. A crypto SMA might be the perfect vehicle to do it.
Matta pointed out using one of the key benefits of SMAs, known as tax-loss harvesting, to offset these gains. In tax-loss harvesting, advisors could shift losses in crypto to these high-performing assets.
While there is plenty of money to be made in crypto, you can lose just as much if you’re not on top of larger market trends. While HNW investors likely have a higher risk tolerance than your typical investor, the swings of even more stable cryptos like Bitcoin are pretty dramatic. Take last year, for example: in July of this year, Bitcoin fell below $30,000, but just three months later, it was dancing near all-time highs of over $60,000.
A managed portfolio offers HNW investors the capability to invest in crypto without the significant research necessary even to get started, much less invest. And with an SMA relationship, through tax-loss harvesting, you can offer some protection from crypto’s ebbs and flows.
“You own the underlying Bitcoin directly in an account in your client’s name, with either 3iQ or another asset manager as a sub-advisor on that account,” Matta explained. “That gives you the ability to offer tax-loss harvesting, which in a space like this where crypto assets are quite volatile, there’s a lot of opportunity to harvest losses in those portfolios for clients.”
Over a year where Bitcoin is allocated in an account, SMAs can offer several opportunities to harvest losses, resulting in improved after-tax returns. He added that all the advantages of equity SMAs are still present, such as trading in custody, performance, and tax reporting.
While Bitcoin was mentioned in this particular example, Matta also spoke about other forms of crypto, including NFTs, DeFi, and the metaverse, which could all be offered to clients.
“When you look at the landscape, SMAs are the ‘shining vehicle’ based on the current landscape that’s out there where you can get great tracking, low fees, and a fully customized approach to tax in addition to having an actual investment manager that can help guide an RIA which you don’t get with a commingled vehicle,” Matta concluded.
For more information about 3iQ’s crypto SMA and the 3iQ Digital Managed Account Platform (Q-MAP), a partnership between 3iQ, crypto-native exchange, institutional-grade custodian Gemini, and BitRIA, visit the 3iQ US website.