This article is based on numerous discussions with FOs, HNWIs, AMs and crypto-friendly banks in the course of services provided by F5 Crypto Capital.
It is an open secret that professional investors such as family offices and (U)HNWIs are busy investing in cryptocurrency assets.
FO = Family Office
(U)HNWI = (Ultra-) High-Net-Worth-Individual
AM = Asset Manager
Last Bull Market
The last bull market, with the peak at the turn of the year 2017/2018, was mainly driven by private investors. Numerous stakeholders, who were spurred on by short-term greed, have left the crypto-universe over the last few months. This process is known as “capitulation”.
Next Bull Market
The sharp drop in prices of all cryptocurrencies, coupled with significant technical developments in the cryptocurrency space and rapid expansion of crypto infrastructure (exchanges, depositaries, banks, financial products), provide fertile ground for a renewed bull market in the cyclical crypto market. There is a consensus in the crypto scene that the next bull market will be driven by institutional capital inflows.
Old Economy meets Crypto
Although private wealth management is considered conservative, it can hardly deny the positive financial aspects of the asset class cryptocurrencies. The emerging supply of financial vehicles in the crypto world is trying to serve the increasing, mostly discrete demand. The first approved and secure crypto certificates and funds have been issued. The largest OTC Desk Circle processed over $ 24 billion in transaction volume for 600 counterparties in 2018. The trend is towards the inclusion of smaller proportions of cryptocurrencies in the portfolio of wealthy individuals.
To further educate professional market players, I will explain the most common investment perspectives of FOs, HNWIs and AMs.
Reason to invest in Cryptocurrencies
From a financial perspective, the very low or negative correlation between cryptocurrencies and traditional asset classes such as equities, commodities, real estate or bonds is particularly interesting. There is no asset class that shares similar characteristics with your average cryptocurrency. The closer the correlation coefficient (-1 perfectly negatively correlated, 0 uncorrelated, 1 perfectly positively correlated) to 0 or negative, the more interesting it becomes when looking to build an efficient portfolio. All cryptocurrencies have a correlation coefficient around 0 (+ – 0.2) compared to the established asset classes.
There is also a difference between the correlations within the cryptocurrencies. It can be observed that the cross-sectional cryptocurrency correlation coefficient increases constantly, but also that it increases in the bear market and reduces in the bull market.
This prior knowledge is the basis of the argument for building an efficient portfolio, as explained in the following section “Diversification”.
Everyone has heard of Markowitz’s portfolio theory. Hailed as one of the most important and influential economic theories dealing with finance and investment, it remains one of the most popular ways to minimise investment risk.  In simpler terms, the key takeaway to remember is: ‘don’t put all your eggs in one basket’. In the best-case scenario, the risk of a portfolio should be minimised without actually reducing the expected return.
The investor can influence his risk-return profile in his favour by spreading the risk over several investments and thus not placing the dependency of the portfolio performance on too few investments. This is also referred to as the reduction of the unsystematic risk (or idiosyncratic risk). On the other hand, there is also systematic risk to bear in mind e.g. the risk that the entire financial or crypto market collapses.
Insofar as family offices or HNWIs already have well-diversified portfolios of traditional asset classes, the still scarce crypto-financial research recommends an allocation of 1.65% to 7.69% of the portfolio assets invested in cryptocurrency.  The allocation percentage is highly dependent on the risk appetite of the asset manager. So far, FOs and HNWIs are allocating at the lower end of the range and consider an investment as a test run for larger volumes.
Adding cryptocurrencies to a traditional portfolio is just the first step. Furthermore, attention must be paid to intra-crypto-diversification. A sufficient diversification effect is achieved when the portfolio has between 10-15 cryptocurrencies that can meet certain parameters in terms of fundamental analysis, security, tradability and liquidity. Extending the portfolio to a higher number of cryptocurrencies is possible, but it doesn’t do much to minimise the idiosyncratic risk. 
The current crypto-ecosystem is not user-friendly. Technically inexperienced family offices and HNWIs face problems in relation to trading, custody, allocation and the legal investment vehicle. As a result, direct investments in cryptocurrencies are uncommon and risk being highly uneconomical where extensive in-house expertise is sought.
Professional investors prefer stress-free financial vehicles with established structures. In Europe, these are mainly crypto certificates (linked bonds), closed crypto investment funds and stock listed shares of Blockchain companies. Again, the principle of diversification applies. Allocation is made in parallel across several investment vehicles.
3. Asymmetrical Risk Profile
The addition of cryptocurrencies offers wealthy institutions a beneficial scenario: one where strong asymmetric risk distribution prevails. The returns do not follow the Gaussian distribution. Under normal circumstances, a symmetrical distribution of risk applies: more risk, more chance and vice versa; less risk, less chance. That convention hardly applies to cryptocurrencies.
The risk-return profile is not balanced. The already increased risk remains at a consistently high level, whereby the potential return can be extremely high. Outlier yields are not uncommon. Yields of x20, x50, x100, x200 have been seen over the last few years – as unbelievable as this may sound to the uninitiated. The investment is limited to the total loss. It is comparable to exercising an option where the upside is virtually unlimited and the downside is limited.
FOs and HNWIs capitalise on this fact by allocating small amounts of cryptocurrencies, that can then be responsible for much of the performance. A meaningful admixture, which is adjusted by the weighting according to risk appetite.
4. Smart Money
Institutional money is often called “smart money”. The money of retail investors is disparagingly referred to as “dumb money”. The smart, clever money can clearly distinguish articles in the media from populist headlines on the one hand, which try to attract attention, and on the other hand, those articles that want to convey a truthfulness of the subject.
While the dumb money camp is dimmed by lurid articles on mainstream media platforms and looks at the short term, the smart money camp scans reliable literature such as whitepapers, working papers or studies and acts accordingly to medium- or long-term plans.
It can be observed that the more FOs and HNWIs deal with cryptocurrency, the larger the allocations become. At F5 Crypto Capital, we assist in the elucidation of financial illiteracy in the blockchain area.
Family Offices and HNWIs often ask themselves where they can achieve returns with a suitable risk profile in the current market environment. The flight into equities, real estate or even the venture capital and private equity areas represent only a few asset classes. The fact is, during the current low-interest phase, it is difficult to construct a truly balanced portfolio.
Although FOs and HNWIs are considered conservative, at least the value preservation approach is an intended trademark, meaning that the inflation of 2% should be outperformed. Since this goal is difficult to achieve due to the lack of profitable investment opportunities, it is again useful to allocate cryptocurrencies and existing, structured investment vehicles to the portfolio. The likelihood of outperforming the adjusted inflation is historically elevated if only a small portion of the portfolio is invested in cryptocurrencies.
Family Offices, High-Net-Worth Individuals and Asset Managers – smart money – have cryptocurrency & blockchain on their radars and tend to have small allocations in their portfolios too. The interest is enormous whilst the investment activity remains somewhat hesitant. The noticeably positive developments in the crypto-ecosystem and comparatively moderate prices, however, give the wealthy a signal that an intensification of investments in cryptocurrencies is timely.
The advantages of cryptocurrencies cannot be denied and the smart money camp is aware of this. The disadvantages are limited. Increasing investment vehicles such as crypto certificates and funds pave the way for legally secure and problem-free investments. The often-rumoured wave of institutional money is gradually piling up and will significantly drive the next cyclical boom and acceptance of cryptocurrency as an asset class.
 Markowitz, H. (1952). Portfolio selection. The Journal of Finance, 7(1):77–91.
 Gasser, S., A. Eisl, and K. Weinmayer (2015): Does Bitcoin Improve Portfolio Diversification?” Vienna University of Economics and Business, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2408997, Accessed: 9th March 2019.
 Elendner, H. (2018): Optimised crypto-currency investment strategies, Humboldt-Universität zu Berlin, https:/f5crypto.com/docs/whitepaper/, Accessed: 9th March 2019.
Contact: florian [at] f5crypto com
Florian Döhnert is a managing director at F5 Crypto Capital GmbH. The views and opinions expressed by Florian are solely his own and do not necessarily reflect those of F5 Crypto Capital GmbH. This piece is for informational purposes only and should not be relied upon for investment decisions.
The author may hold long or short positions in the securities discussed.