Why would one want a separate portfolio allocation to blockchain technology? It’s a question nagging many professional investors as they see headline after headline on the topic.
In our view, the thesis is somewhat similar to sector investing: It can help advisors express thematic market views and/or capture potential alpha opportunities. Traditional sector opportunities may be growth-oriented, like technology funds, or income- and volatility-focused like utility funds, or potential inflation hedges like real estate and other real asset funds. In all, sector plays are a significant part of the investment universe, to the tune of over $750 billion in sector mutual funds and ETFs.
In the same way, an actively managed blockchain sleeve can add specific exposures to an equity portfolio, in particular:
- a strong growth orientation;
- a global tilt to that growth; and
- a small/SMID tilt, as many of these current opportunities may be with smaller-cap companies just finding their markets.
Unlike single-sector funds, however, blockchain is a thematic play that cuts across multiple industries, from finance, to retail, to multiple parts of the tech sector (software, hardware and semiconductors). Blockchain is diversified along supply chains as well, where upstream companies make hardware and software to support blockchain systems; midstream companies aim to profit directly from blockchain technology adoption; and downstream companies accept payments or transactions based on blockchain-based currencies.
What’s Driving Growth? Potential Disruption Across 30 Industries
Blockchain technologies are disrupting a lot of industries, chief among them being financial services. Take transaction banking, where blockchain technology is lowering costs and fees, according to a Bain & Co. study. So, banks piling into this space may be in for a rude awakening as downward fee pressure potentially turns an attractive, profitable business into a low-fee, commoditized business in a matter of a few years.
This kind of disruption isn’t just happening in financial services. In retail, Overstock and Shopify are working quickly on enabling payments using cryptocurrencies. Walmart is using blockchain to improve inventory management. Global automakers are planning to apply blockchain technology to vehicle and consumer data. Chip manufactures each have exposure to different parts of the blockchain ecosystem, and thus, different prospects for long-term success.
We estimate that at least 30 industries could get swamped by a wave of blockchain innovation over the next couple of decades—from banking, to cloud computing, to energy management, to government and public records, to anything involving intellectual property.
An Actionable Investment Thesis
The ins and outs of blockchain can be complex. Some established firms excel at development and adoption (e.g. Overstock), while others put out blockchain press releases with nothing to back them up (e.g. Long Island Iced Tea). In the same vein, startups can offer radically transformative tech, or gimmicky flops.
It may take a blockchain specialist to uncover the difference, which is why we believe active management is essential in this space, where few analysts fully grasp the intricacies and potential impact of the technology — we believe that informed experts have the potential to add significant value.
As for cryptocurrencies (which are just digital tokens residing on a blockchain), our view is that in the long run, they could become an entrenched part of the global payments network. But right now one has to consider them more like venture capital or hedge fund investing.
Yet, equity investors may still find strong potential opportunity in the chipmakers, software/app developers, and “mining” companies that make up the backbone of the crypto ecosystem. This kind of indirect exposure may provide access to the secular growth trend without the volatility of investing in cryptocurrencies themselves.