The first U.S. Bitcoin-linked exchange-traded fund, called ProShares Bitcoin Strategy ETF (ticker: BITO), hit the market in mid-October and has taken it by storm.
The fund has grown at record speed, already amassing $1.3 billion in assets, with an average daily trading volume of 10.4 million.
BITO lets investors gain exposure to Bitcoin without needing to own it themselves. The fund principally invests in Bitcoin futures contracts rather than the coin itself. Futures contracts are standardized agreements between two parties to buy or sell the underlying asset — in this case, Bitcoins — at a predetermined date and price, allowing investors to speculate on the future price of an asset. But using futures contracts on Bitcoin presents its own challenges, such as the fact that the Chicago Mercantile Exchange, or CME, caps the number of contracts funds can hold.
To learn more about BITO’s strategy and what financial advisors should know, we spoke with Leks Gerlak, an investment strategist and key member of the BITO team at ProShares. Here are edited excerpts from that interview.
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How does trading in Bitcoin futures impact the ETF’s tracking error relative to Bitcoin’s actual price and its risk profile?
Trading in Bitcoin futures reflects the best representation of Bitcoin value. Therefore, the fund should reflect the value of Bitcoin.
It’s important to understand that there is no single reference price for Bitcoin, and the trading price of Bitcoin varies from one exchange to another, often between 1% to 2%, and sometimes by 4% to 5%. Expert research on this topic finds that the Bitcoin futures market dominates the price discovery process, compared to Bitcoin exchanges, and plays a more important role in determining the value of Bitcoin.
Over the past few years, Bitcoin futures and Bitcoin have historically provided very similar returns. Both correlation and beta have been very close to one to Bitcoin.
[See: What’s the Best Cryptocurrency to Buy Now? 7 Contenders]
Given Bitcoin’s notorious volatility, how will you manage?the risk exposure of using futures — especially longer-term futures — in BITO?
BITO is designed to provide investment results that generally correspond to the performance of Bitcoin.
If Bitcoin is volatile, BITO should be volatile. The use of longer-dated futures shouldn’t have much of an impact on that.
Investors should only consider a Bitcoin-related investment if they are comfortable with the historic volatility of Bitcoin.
How do you plan to manage the strategy as the fund grows, given CME imposes caps on the number of futures contracts you can hold?
There is a lot of misunderstanding on this topic of capacity and the number of futures contracts that BITO can hold.
There are three buckets of futures contracts that BITO can hold:
First, you have the front-month contracts (with the nearest expiration date to the current date), where we can hold up to 4,000 contracts. This amount doubled from 2,000 as of Nov. 1.
Then you have the other month contracts outside of the front month. There is no set limit on the number of non-front-month contracts that can be held. Above 5,000 of these contracts, the exchange can ask holders for additional information and can make a determination to restrict the number of contacts that can be held.
Finally, there are also additional front-month contracts that could be bought under an exemption the exchange may grant, which we believe we should qualify for.
BITO generally seeks to remain fully invested at all times in Bitcoin futures. We will actively manage the roll of futures contracts in order to achieve the appropriate exposure and to minimize costs. Our approach to rolling futures is intended to eliminate or minimize any potential impact of this limitation.
[Read: Q&A: How Financial Advisors Talk About Cryptocurrency With Clients.]
What role could BITO play in a client’s portfolio?
Investors may use BITO to gain exposure to Bitcoin performance through a simple method of buying an ETF through a brokerage account, like a stock.
Many experts now advocate for a small allocation to Bitcoin in a portfolio, and Bitcoin can have many roles in a portfolio. For example, it can be used as a replacement for certain portfolio allocations, such as real estate, gold and commodities.
It can also be used as a complement or diversifier to other traditional asset classes, such as stocks and bonds. Investors may additionally view this exposure as a way to seek capital appreciation.
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Q&A: What Advisors Should Know About the BITO ETF originally appeared on usnews.com
