Non-traditional asset classes can be the shiny new toys on the shelf. As a 401k advisor, when is it responsible, and potentially a fiduciary obligation, to consider them for an investment menu even if they have a potential taint of controversy—like cannabis or cryptocurrency?
Let’s start with cannabis, which one researcher says is expected to grow in the U.S. from $8.3 billion to nearly $25 billion in 2025, a compound annual growth rate (CAGR) of 14.7 percent, with other reports that its CAGR could be as high as 26 percent.
For comparison, the U.S. video game industry is expected to reach $20.3 billion in 2020, which represents a 3.6 percent CAGR.
Despite widespread state legalization, cannabis is still considered a Schedule 1 drug under the Controlled Substance Act, putting it in the most restrictive category under federal law—and making investors wary of jumping into the industry.
In early 2018, then-U.S. Attorney General Jeff Sessions tried to pour more cold water on the industry by rescinding the Cole memo, which limited a prosecutor’s ability to enforce criminal marijuana laws in states that had legalized its usage and in turn, opened up markets to be governed by state laws.
The hardline that Sessions hoped for has largely not materialized, and in fact, policymakers on both sides of the aisle are pushing for changes that will likely invigorate the legalization movement even more.
In April, senators received assurance from President Trump, who appeared to walk back Sessions’ earlier move and instead allow states to best decide how to approach cannabis in their locales.
Sessions resigned in November and until his replacement is named, the cannabis enforcement environment will likely remain unchanged.
Still, the lack of a federal mandate creates investment uncertainty and advisors are looking for ways to stay on the right side of regulations, while also wanting to satisfy their clients’ interest in the fast-growing market.
Getting Around Cannabis Uncertainty
Richard Acosta may have found a way to capitalize on the cannabis market, while minimizing risk and uncertainty. He’s CEO of Inception REIT (I-REIT), which is billed as a first-of-its-kind platform, focusing exclusively on providing real estate debt and equity capital solutions to the rapidly growing U.S. medicinal and adult-use cannabis industry.
The lack of state and federal continuity has created an obvious gap in the capital market for cannabis, according to Acosta, keeping traditional financing sources away from the industry.
“At a high level, the I-REIT fills the void that occurred when banks were unwilling to work with the cannabis industry after the Department of Justice issued their statement,” says Acosta. “We are acting in their role as lender and landlord by providing loans, as well as buying real estate and leasing the buildings back to cannabis operators.”
He notes that there is a “supply and demand mismatch” for cannabis real estate capital that has provided his company with higher-than-expected returns. If traditional REITs average 4 to 5 dividend rates, he estimates that I-REIT’s returns are double that average.
I-REIT’s approach also provides a layer of protection if a black swan event occurs, such as the federal government cracking down on cannabis. If the drug became illegal tomorrow, Acosta’s group would still have mortgages and assets and they would just find new leases.
“We are backstopped by the value of our real estate, so we would reposition the portfolio to service non-cannabis clients.”
Though the I-REIT provides some guardrails to cannabis investing, the fund still isn’t being marketed to advisors directly. But that could change.
Plan administrators are initially hesitant about cannabis funds for all the expected reasons (regulation, valuation), but with millennials investing in cannabis stocks at an explosive rate according to the trading app Robinhood, the hesitancy could give way to employee demand.
For now, investors can use a self-directed IRA to move funds from a traditional IRA and invest in a vehicle like I-REIT. This could allow them to earn potentially high single-digit dividends off of retirement savings and grow it more quickly by investing in an under-capitalized market—one that’s growing even faster than the Dotcom boom.
Or they can invest in the manufacturers that supply cannabis grow operations.
Acosta sees these as good options for individuals who don’t have large cash savings, especially millennials and xennials, to invest with a portion of their long-term IRA funds and potentially receive higher yields on those funds. It’s also another way to diversify a portfolio with a more recession-resistant investment.
As cannabis lights up the investing space, Acosta thinks interest will increase, as well. “No question, I think people are starting to get religion around the exuberance in the cannabis space.”
Bitcoin, the Investment Hellion
If cannabis is the cool kid waiting for mainstream acceptance, bitcoin is the brash, erratic hellion that might kill someone someday.
Tracking its growth can be a dizzying task with a value history of “basically nothing” in 2009 to spikes that reached $5,000 per bitcoin in September of 2017, only to slump within a week to $2,900.
Next, came a run up to nearly $18,000 several months later, yet at the end of 2018, it was down to the low $3,000s after experiencing a relatively stable period of volatility at its 10-year anniversary.
It may have had a hot history of financial growth, but some see it as a hot mess.
Keith Clark has been watching bitcoin since its inception and is not shy about the pros and cons of the digital currency.
He’s the co-founder and managing partner of DWC – The 401k Experts, in addition to being an adjunct professor at the University of Minnesota Carlson School of Management.
“I’m fascinated with financial markets and currency,” he says, “but I’m an academic at heart.”
Clark has been keenly interested in the rise of bitcoin and other cryptocurrency and recognizes that the skyrocketing value entices investors, prompting some to look at adding it to 401k plans or other retirement savings vehicles.
But not so fast, he says. There’s a lot of investors and advisors that need more information about this futuristic-sounding currency, starting with the basics.
As Clark explains, bitcoin and the multitude of other cryptocurrencies that have sprung up rely on something called blockchain technology, which is a computerized ledger system that processes transactions (completed blocks) via secured wallets and keys.
The three biggest differences between cryptocurrencies and traditional government-issued currency are:
- Cryptocurrencies are digital and stored on a blockchain.
- Cryptocurrencies have zero government oversight, which Clark sees as the greatest variable to success in a popular marketplace.
- Bitcoin supply is limited or defined based on mining, unlike government-issued currency, which governments can print more of or shrink supply based on demand.
Its rush appearance on the investment scene has changed the way people view currency overall, observes Clark, similar to how services such as Venmo, which was a relative unknown three years ago, has changed the way we deal with payment sharing and banks.
“Most of my daily calls are from advisors and plan sponsors. The advisors are getting asked about bitcoin and they want to know what their liability is and what they can do for participants and plan sponsors.”
Bitcoin, the Investing Enigma
The fact is, there is not a fund in the U.S. that currently invests exclusively in bitcoin or cryptocurrency, which puts it at odds of being included in any mainstream 401k plan.
However, bitcoin is available for investment with monies outside of a company plan, says Clark.
“For example, you can already access it through a self-directed IRA, which could be a good option as it encourages investors to do this outside their 401k with IRA or after-tax monies.”
There are other investing routes, such as bitcoin futures, but Clark reminds that they are only accessible by brokerage accounts that permit purchases in these exchanges.
Or investors can look at the companies behind bitcoin technology. One example is China-based Bitmain, the powerhouse company responsible for the chips that mine bitcoin. Bitmain hit $2.8 billion in revenue in the first 6 months of 2018.
It also just filed an IPO, which will allow retail investors into the company for the first time.
Bitcoin Dreams Meet Fiduciary Responsibility
Then there’s the fiduciary element.
Litigation tied to fiduciary responsibility has been riling plan sponsors over the last few years with jaw-dropping settlements making industry waves.
This means you will most likely not see bitcoin as an investment option until there is government oversight and efficient trading platforms within a 401k plan, according to Clark.
However, he’s explored the greater consideration for plan fiduciaries in that they must act in the best interest of plan participants.
Clark says this is the question a fiduciary must ask: Do they want to permit investments that are not regulated in any way, shape or form by any government? (He concedes that the futures exchange is regulated, but the underlying investment is not.)
Bitcoin has zero protection for the investor in the event of fraud, unlike traditional investments that have FDIC or SIPC protections.
Another quirky issue: a bitcoin wallet has one very long password that is permanent and it can never be reset.
If and when bitcoin makes it into the 401k portfolio, who would hold the password, and would the exposure to fraud be even greater? What if plan sponsors permitted each participant to have their own wallet and then they lost their wallet?
At last count, 25 percent of bitcoin that were in circulation ($18 billion in value) is unrecoverable because of lost keys or wallets. The legal exposure for plan sponsors in this scenario is obvious.
One Step at a Time
Clark’s take on the future can apply to either cannabis or bitcoin.
“Every financial institution is watching, but no one wants to take the first step. Our industry is historically slow moving. Education is what moves the needle…every article that is written on this topic will inform advisors and plan sponsors.”
He remembers when plan sponsors would not allow more than 5 to 10 percent of the fund menu to be made up of mutual funds with international exposure as a risk-mitigation strategy. It’s a restriction that did not last long.
“Now they are in every fund,” he laughs, while noting that socially responsible investments were nothing 10 years ago yet today are all the rage.
Who’s to say it won’t happen with cannabis and bitcoin investing?
Lynn Brackpool Giles is former Managing Director of Communications and Consumer Services for the Financial Planning Association (FPA). In this senior management role, she oversaw all corporate and strategic communications, media relations, legislative communications and consumer affairs for the national association.
Lynn Brackpool Giles is a contributing editor to 401(k) Specialist. Giles is a former Managing Director of Communications and Consumer Services for the Financial Planning Association (FPA), where she oversaw all corporate, legislative, and consumer communications. In her current journalistic practice, she is a frequent contributor to numerous financial services industry publications.
