Five Reasons for Financial Advisers to Outsource to a Crypto SMA

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A widely expressed view in traditional financial media is that digital (crypto) assets represent an exciting yet highly risky and poorly understood asset class. Industry spokespeople typically suggest that investment advisers should exercise caution engaging, and instead focus on “getting educated”. While we 100% support the importance of education, we also strongly believe that there are great opportunities available today for advisers to offer their clients the growth and diversification benefits of digital assets, while continuing to get educated themselves. The Crypto SMA (Separately Managed Account) is one such opportunity.

A Separately Managed Account enables a professional asset manager to individually trade and allocate the underlying assets in a client’s portfolio. The case for leveraging a SMA goes well beyond cryptocurrencies, with a history of debate in the traditional asset management world weighing the benefits of SMAs vs. other investment vehicles. In this article we review the benefits and limitations of SMAs from traditional literature, and evaluate how they translate to crypto SMAs. While the crypto ecosystem does not currently offer the same diversity of investment vehicles as the traditional asset space, the comparisons are nevertheless relevant.

Benefits of SMAs

Crypto SMAs enjoy most of the benefits of traditional SMAs, together with extra advantages that are unique to the crypto ecosystem.

Taxes

Perhaps the greatest benefit of leveraging an SMA in the traditional world is customizable tax treatment. By owning the underlying assets, the asset manager can harvest the losses of specific investments for the client based on the specific lot information of that client, along with offsetting gains outside of the portfolio. This level of tailored tax treatment is just not possible with ETFs and funds, where the aggregate capital gains is assessed equally across all investors holding the security.

The volatility of crypto makes the benefits of custom tax treatment even more pronounced. Having the capability to offset substantial capital gains by selling equally substantial losses can put the client in a more favorable tax situation. This is also easier for a crypto SMA since they do not need to (for the time being) act in accordance with wash trading rules due to crypto’s classification as digital property. In the traditional world an equity can not be repurchased for 30 days after a sale. The traditional asset manager needs to take this into account so they don’t lose out on future gains in the 30 days after the loss has been harvested. This often leads to the use of substitute products when available, whereas in crypto the asset can be harvested and repurchased right away.

Customization

Customization has become more important as a benefit of SMAs due to the rise of ESG investing. A client that does not want to be invested in oil & gas companies cannot simply ask the ETF or Fund manager to remove Chevron from the allocation. SMAs make this process easier by allowing the asset manager to remove the equities specifically within that client’s portfolio.

Customization also provides tremendous benefits by tailoring a client’s portfolio based on other investments that the client has. Imagine, for example,  a client who is an employee at Square with stock options representing a substantial portion of their net worth. Customization of the SMA will be imperative to allow the asset manager to adjust their allocations for their large holdings of a single fintech stock. This benefit is certainly more valuable in the traditional space than in crypto today, primarily due to the use cases for specific crypto assets still being defined. But as time passes and crypto networks prove themselves to be competitors to the centralized networks created by corporations, tailoring specific crypto investments based on outside client holdings will become more important.

One of the most important aspects of customization relates to suitability. Many investment vehicles are one-size-fits-all, which can become an issue when advisors are looking for the right solution to serve their client base. A great example of the flexibility that an SMA provides in the crypto space is putting younger clients into more diverse, actively rebalanced strategies and older clients into large cap-focused buy & hold strategies.

The value of customization really comes down to taking the client’s preferences into consideration. If those preferences are ill-founded, it is the adviser’s duty to try and change their views, but in the end the client’s requests must be honored. When it comes to crypto, the client may have strong convictions about specific crypto assets, so leveraging an SMA allows their portfolio to be tailored according to these preferences.

Transparency

When dealing with ETFs or funds, the actual transactions and holding level returns are somewhat obscured due to the structure of the investment. SMAs have the added benefit of transparency of all investment activity provided to the adviser and client, who are able to see all the trades incurred along with the returns on each individual holding. This allows performance to be more accurately judged, and the client is able to glean deeper insights to their portfolio that are not possible with other vehicles.

In our view, the benefit of transparency transcends all asset classes, especially cryptocurrencies. With crypto asset managers still proving themselves, it is imperative that advisers and clients have visibility to the detailed information about how the portfolio is being managed.

Benefits Unique to Crypto SMAs

Lastly, we review two benefits that are unique to the world of crypto SMAs.

Yield Generation: Crypto is seeing a blossoming of yield generating activities, the two largest drivers being lending and staking. While these benefits can be attained through other vehicles, only an SMA affords the advisor the ability to determine the exact level of risk they feel comfortable exposing the client to to achieve a given yield.

Leverage the Expertise of Firms with Crypto Experience: In the crypto ecosystem many advisers want to be able to offer their clients the benefits of owning the underlying digital assets vs. a Fund, but lack the expertise or the tools to manage portfolios directly themselves. Crypto SMAs bridge this gap by allowing advisers to outsource the management of their clients’ digital asset positions to firms with demonstrated experience in the asset class.

Crypto SMAs also allow advisers to benefit from the specific investment expertise and theses of a range of asset managers – from firms with a more conservative approach to digital-first asset managers with deep knowledge of the DeFi ecosystem, and even ESG.

Limitations

Let’s now look at some of the common limitations of traditional SMAs and to what extent they apply to crypto.

Minimums

The primary limitation of SMAs is directly related to the cost associated with having someone customize the management of your portfolio: there are substantial minimums to getting started. In the traditional space account minimums can be anywhere from $50,000 to $300,000.

For existing crypto SMAs there is no meaningful minimum. One reason for this is that because an allocation to crypto is usually small (typically 1% – 5% of a client’s portfolio), it simply isn’t realistic to require such large minimums. A second reason is that because the crypto industry is relatively new, there is not yet significant demand for crypto SMAs compared with traditional SMAs. Having fewer clients allows the existing crypto SMAs to service smaller accounts. While this may not always be the case, and capacity will be dependent on the crypto SMA in question, we foresee negligible minimums for crypto SMAs well into the future.

Due Diligence Effort

Specific to the crypto industry, choosing the right SMA requires more due diligence than other options. This is because crypto investment options and theses are newer and generally less well-understood, and the analysis options are somewhat limited at this relatively early stage. While this is an unavoidable drawback, we are continuing to see more information evolving about the different crypto SMA options, and tools to help track their performance. This topic is explored further in our next article, “Questions to Ask When Choosing a Crypto SMA.”

Conclusion

In our view, crypto SMAs share all the benefits of SMAs in the traditional asset ecosystem together with enhanced advantages in the areas of transparency and taxes. In addition, crypto SMAs offer unique yield-generation capabilities such as staking and lending. Overall, leveraging a crypto SMA offers the client and their advisor significantly more benefits than limitations when it comes to the management of their crypto allocations.

Crypto SMAs offer a great opportunity for advisers to expose their clients to digital assets, with all the benefits of owning the underlying assets. By leveraging the expertise of SMA firms with experience in crypto and a range of investment theses, advisors can offer digital assets today, while continuing to educate themselves on the asset class.

To learn more about Crypto SMA options, please visit our SMA Network page.