With the Elwood Global Blockchain index’s 78% gains over the past 12 months far outstripping the wider market, it is reasonable to question whether ETFs tracking such benchmarks are merely enjoying a faddish burst of thematic investing and cryptocurrency mania, or whether they offer a legitimate avenue for those seeking exposure to long-term uncorrelated assets.
Addressing this is a recent report authored by Scott Chronert, managing director and global head of ETF research at Citi, titled Uncorrelated Growth Opportunities in Blockchain ETFs, which posits a handful of thematic ETF classes offer compelling opportunities for alpha generation as equities transition into the post-pandemic world.
The report’s core assertion is that the suites of blockchain ETFs available in Europe and the US currently represent a good opportunity for diversification, given what Citi considers to be “muted” connections with macro and factor considerations.
There has been some overlap between blockchain strategies and growth-focused products, the report said, however, the connection between the two exposures that existed between 2017 and 2020 has subsided since the second half of last year as the blockchain theme received greater news coverage and practical applications.
In fact, the blockchain thematic ETF category and growth factor have moved largely in opposite directions since last September but the report warned against drawing connections between economic cycles and the performance of blockchain equities.
The main cause of blockchain’s idiosyncrasy, Chronert said, is based both on the intensity of news coverage and the actual adoption of blockchain technologies.
These two factors themselves are in fact linked, the report continued. Given the nature of the asset class blockchain often underlies, prolonged exposure to the public eye has coincided with greater demand for crypto investment – and thus blockchain technology.
On the one hand, if investors accept these as grounds enough for believing the non-correlated potential of blockchain ETFs, they then ought to question whether correlating with boom-and-bust cycles and faddish investment is a preferable option. This probably depends on an individual’s risk tolerance and beliefs about the prospects of widespread blockchain adoption.
On the other hand – as is often the case with future thematic ETFs – the contents of blockchain products are not all as exotic as the label on the tin.
Looking under the bonnet of the Invesco Elwood Global Blockchain UCITS ETF (BCHN), for instance, an onlooker will find a number of blockchain pure-plays interspersed with diluting, large-cap names such as Rio Tinto, SoftBank, Santander, Mitsubishi Financial, Taiwan Semiconductor, Samsung, Advanced Micro Dynamics and Tesla.
Thankfully, over the last year at least, the ‘placeholder’ elements in ETFs such as BCHN do not seem to have dampened their non-correlating potential with the product differentiating significantly versus the behaviour of popular factor, core equity and aggregated fixed income strategies.
The main correlation seen in the graph above is between BCHN - green line - and BlackRock’s now-infamous iShares Global Clean Energy UCITS ETF (INRG) - yellow line - and the reasons for this are twofold.
First, both clean energy and blockchain technology were swept up in the pandemic mania which drove unprecedented sums of assets into future-industry thematic ETFs.
The explanation for why these inflows had such a pronounced impact on the returns of BCHN and INRG leads onto our second reason: both had significant exposure to disruptive, small cap pure plays. These small companies suddenly became the recipients of large sums of speculative capital, causing their valuations to skyrocket.
The differentiation between the two ETFs comes in 2021 where the cyclical recovery saw INRG’s price crash by a third in three months while BCHN exhibited a more modest climbdown – roughly tracking the momentum of bitcoin.
Despite the well-acknowledged link between blockchain and crypto assets, Peter Sleep, investment manager at 7IM, said investors should resist synonymising the two.
“Blockchain is a concept and it is very difficult to invest in ideas like blockchain, particularly if its software is open source,” Sleep continued. “If you want to invest in bitcoin then invest in bitcoin ETPs.”
Sleep was also somewhat undecided as to whether GICS sector large-cap equities such as banks have a place in blockchain ETF baskets. While companies such as Santander might increase their usage of blockchain for back-office tasks, including mainstream companies based on some involvement in the technology will lessen the performance impact of volatile, innovative disruptors and ultimately increase blockchain strategies’ correlation with the norm.
“I would have thought you do not want correlation with the broader market, or what some advocates call ‘placeholders’. I guess you want companies that are focused on blockchain and will grow rapidly with that market,” Sleep continued. “I am not a blockchain expert, I am not sure Santander is going to grow rapidly with blockchain.”
While noting the findings of the Citi report and potential implementation of blockchain capabilities in mainstream finance, Sleep cautiously concluded: “It is fair to say it is too early to say what it is correlated with.”
Another issue is then raised by the more developed suite of blockchain strategies over in the US – potentially vast differentiations between the contents of the eight ETFs on offer.
Illustrating this, there are considerable differences in allocations to respective sectors within each product with a 52% range in ETFs’ weightings towards the information technology sector and a 21.4% disparity in allocations to financials.
Such differences are significant and mean the extent to which blockchain products can provide non-correlation depends entirely on the design of individual ETFs’ underlying indices.