Asset Management in Focus - Edition 1
Welcome to Asset Management in Focus, a series which has been designed to give you an in-depth look into topics within the Asset Management sector. In this edition Conor Moroney, a Director in KPMG’s Asset Management practice, sets out below some of the pros and cons of investing in Digital Assets for asset managers, and how KPMG can help in supporting clients to navigate this emerging asset class.
Asset managers are always on the lookout for new investment opportunities that can provide consistent returns while minimizing risk. In recent years, digital assets, which include cryptocurrencies, digital tokens, and blockchain-based assets, have emerged as a new and exciting asset class that some asset managers have started to invest in. However, investing in digital assets comes with both pros and cons that asset managers must consider before making any investment decisions.
Pros of investing in digital assets
High potential returns: Digital assets have generated high returns for some investors in the past. The asset class is attractive to those risk tolerant investors seeking to generate higher returns than traditional asset classes.
Diversification: Digital assets are a new alternative asset class with no correlation to traditional asset classes like stocks, bonds, and real estate. As such, investing in digital assets can provide diversification benefits to an asset manager's portfolio.
Liquidity: Some digital assets, like cryptocurrencies, are relatively liquid which means they can be easily bought and sold on digital asset exchanges. This makes it easy for asset managers to enter and exit positions quickly, which can be important in volatile markets.
Transparency: Most digital assets are based on blockchain technology, which provides a high degree of transparency. This transparency can be useful for asset managers in conducting due diligence on potential investments.
Access to emerging asset class: A major advantage of digital assets is that they provide asset managers with access to new asset classes that were previously unavailable. This enables diversification of portfolios and potentially higher returns, as well as the ability to hedge against market volatility.
Access to new investors: Digital assets can also provide access to new investors, especially those who are tech-savvy and looking to diversify their portfolios. Through digital platforms, asset managers can reach a wider audience and offer investment opportunities to individuals who may not have had access to traditional investment channels.
Cons of investing in digital assets
Volatility: Digital assets, especially cryptocurrencies, are known for their high volatility, which can lead to significant losses for investors. Since 2020, for example, the price of Ethereum rose from around $130 per coin to nearly $4,600 before crashing back down to around $1,800 by Q1 2023.
Regulatory risks: Digital assets are a new and largely unregulated asset class. The regulatory environment is evolving in this space which brings additional compliance and monitoring risks on asset managers.
Security risks: Digital assets are vulnerable to theft and hacking, which can lead to significant losses for investors. In 2014, for example, the Mt. Gox exchange, which was then the world's largest Bitcoin exchange, lost 850,000 Bitcoins, worth around $450 million at the time, to hackers.
Due diligence challenges: The lack of standardised regulations and frameworks for digital assets can make it challenging for asset managers to perform due diligence effectively. The risks associated with digital assets, including cybersecurity risks and regulatory risks, can also increase the complexity of due diligence processes. Additionally, the rapidly evolving nature of the digital asset space can make it difficult for asset managers to keep up with new developments and assess their potential impact on investments.
How can KPMG support asset managers?
Despite the challenges associated with investing in digital assets, KPMG can support asset managers in navigating this rapidly evolving asset class. Here are some examples of the types of services that we can offer:
Accounting services: Digital assets present unique accounting challenges that many traditional asset management firms may not be equipped to handle. KPMG continues to grow our specialisation in digital assets to allow us to assist asset managers with tasks such as tracking and valuing digital assets, managing regulatory risks, and conducting audits for digital asset focused investment funds.
Regulatory compliance: Digital assets are largely unregulated, but that is changing rapidly. KPMG can assist asset managers in navigating the complex and evolving regulatory landscape, ensuring that they remain compliant with relevant laws and regulations.
Tax advisory: The tax treatment of digital assets is still evolving, and it can be a complex and challenging area for asset managers to navigate. KPMG can provide guidance on tax-related matters such as capital gains, income tax, value-added tax (VAT) and tax structuring.
Custody and security: Digital assets are vulnerable to theft and hacking, which can lead to significant losses for asset managers. KPMG can provide guidance on best practices for custody and security of digital assets, including secure storage solutions and cybersecurity measures, as well as third party custodians.
Due diligence: Due diligence is a critical aspect of any investment decision, and it is especially important when it comes to digital assets. KPMG can provide asset managers with detailed due diligence reports on potential digital asset investments, including assessments of the technology, teams, regulatory environment, and exchanges.
Strategy development: Developing a sound investment strategy for digital assets requires a deep understanding of the asset class and the market. KPMG can assist in up-skilling asset managers to help them to develop their investment strategy plan which aligns with their risk tolerance and investment objectives.
What should asset managers do next?
In conclusion, investing in digital assets can provide asset managers with opportunities for high potential returns and diversification, but also comes with significant risks such as volatility, regulatory risks, security/ custody risks, and a lack of understanding. KPMG can assist asset managers in navigating the challenges associated with digital assets, providing accounting, regulatory compliance, tax advisory, custody and security, due diligence, and strategy development services. Ultimately, the decision to invest in digital assets should be based on a thorough understanding of the asset class and its associated risks, as well as a solid investment strategy that aligns with an asset manager's risk tolerance and investment objectives. We are here to help.
If you would like assistance with any digital asset related question, please don't hesitate to contact our team below. We would be delighted to hear from you.
More in our Asset Management in Focus series
Contact us
Maria Flannery
Partner, Asset Management Audit, Head of Digital Assets
KPMG in Ireland
Conor Moroney
Director
KPMG in Ireland
