Setting Boundaries: Defining Active and Passive Management for Crypto
Jul 10, 2023
Since the creation of index funds, allocating between active and passive management remains the subject of great debate among investors. Over time, the boundary lines between active and passive investment vehicles for traditional asset classes have become better defined, benefiting from decades of analysis and product development. Unfortunately, the same cannot yet be said for crypto investment products.
Advisors investing in established asset classes today are tasked less with disentangling “active” vs. “passive” and more with determining how much active risk to take on for clients, and choosing the most sensible ways to do so from an accessible, well-populated landscape of highly competitive investment vehicles.
For advisors interested in digital assets, the task is doubly challenging because “active” and “passive” investment options are still only nascently defined and starkly lacking in both sophistication and ease of access.
Looking Through an Active/Passive Lens for Crypto
What does “active management” look like for crypto today? The following framework lays out the crypto investment landscape currently available for advisors, divided into three categories with pros and cons for each as well as their active or passive nature.
1. Single Token Buy-and-Hold
Often implemented directly via exchanges, through separately managed account platforms (SMAs), or investment trusts (especially in the absence of SEC-approved spot ETFs), buy-and-hold is the most simplistic way to add digital assets to an overall portfolio.
Direct access to crypto
Low portfolio management overhead
Potentially more accessible via advisors’ existing wealth technology platforms
Lack of diversification
Clients can independently obtain exposure
Potentially outsized management fees for naïve exposure
Certain vehicles may introduce unintended risks
Active vs. Passive: This represents passive exposure to a subset of digital assets (commonly BTC and ETH), but without the diversification and risk-management benefits of typical rules-based passive indices.
2. Automated Indices
Automated indices provide a rules-based framework for crypto exposure to a broader number of assets (often the top 10-25 assets by market cap) and systematically rebalance to meet portfolio construction goals. Currently, U.S. investors often access these products through multi-asset SMAs.
Improved diversification and outperformance potential vs. single-token exposures
Rules-based portfolio construction creates consistent exposure to the broader crypto market
Current options often lack nuanced thematic or sector-specific allocations or personalized customization
Typically higher-touch onboarding process vs. individual buy-and-hold
Potential underperformance vs. actively managed products
Active vs. Passive: While some tout the automated nature (i.e., rebalancing) of these products as “active,” these should be considered purely passive exposures akin to index funds for traditional asset classes.
3. Quantitative or Discretionary Management
Active managers construct strategies that leverage discretionary blockchain expertise and quantitative on-chain analysis to provide sophisticated crypto exposures. These are often accessed via hedge funds or specialized SMAs.
Institutional-grade expertise for a rapidly developing and technical asset class
Potential for risk-adjusted outperformance and/or reduced correlation to the market
Often superior risk management and trade execution
Accessibility hurdles often exist, including limited capacity or high investment minimums
Manager selection may be challenging due to shorter track records
May exhibit periods of underperformance vs. passive products
Active vs. Passive: This represents true active management commensurate with standards for traditional asset classes.
Bringing Crypto Investment Products into Focus
The developing nature of the digital asset investment product landscape leaves the delineation between active and passive investment products, and how to access them, fuzzy at best. Ultimately, more clearly defining the available active and passive options and how they relate to traditional investment evaluation frameworks will equip advisors to more confidently select the most appropriate digital asset solutions for their clients.