As we tally up the body count from the FTX fiasco, one of the more notable appearances on the list of casualties was Canada’s Ontario Teachers Pension Plan (OTPP) – a teachers’ superannuation fund if you’re Aussie.
Following its US$95 million investment into FTX, it has now announced that it is “writing it down to zero”, best conceived as an admission that the investment is probably worth absolutely nothing. OTPP has been slammed for making the investment in the first place, posing the question as to what Aussie super funds can learn from the entire debacle.
The investment in a nutshell
In its statement, OTPP said that it invested US$95 million in FTX International and its US entity, “to gain small-scale exposure to an emerging area in the financial technology sector”. It said:
“Our investment represented less than 0.05% of our total net assets and equated to ownership of 0.4% and 0.5% of FTX International and FTX.US, respectively.”
Naturally, the pension plan added, “not all of the investments in this early-stage asset class perform to expectations, however, since inception, TVG [OTPP’s venture arm] has delivered solidly on intended objectives”.
The statement addressed the issue of due diligence, saying that it conducts “robust due diligence on all private investments”, supported by, “experienced, external consultants with financial, commercial, and other relevant expertise”.
It described the alleged fraud at FTX as “deeply concerning”, but that in the process of conducting due diligence on the firm, had worked “closely with third-party advisors and FTX to explore commercial, regulatory, tax, financial, technical and other matters”. After reiterating its commitment to diversify investments and that it takes “all losses seriously, it concluded that:
“We will be writing down our investment in FTX to zero at our year end”.Ontario Teachers Pension Plan statement
Not the only pension fund caught out with crypto investments
OTPP isn’t the only pension fund who got caught offside with a bad crypto investment. In August this year, a US$429 billion Canadian pension fund, Caisse de Depot et Placement du Quebec (Caisse), decided to write off its stake in bankrupt crypto lender Celsius.
The fund had invested US$150 million in Celsius during the height of the 2021 bull market, saying, “Blockchain technology has the potential to disrupt several sectors of the traditional economy. As digital assets grow in adoption, we intend to capture the right opportunities, while working with our partners towards a regulated industry”.
Now the fund has decided to completely write down that investment to zero as its CEO Charles Emond said during a webcast that the fund “arrived too soon in a sector which was in transition”. Too soon or a failed due diligence?
Not unlike the situation at OTPP, Emond added that Caisse conducted “extensive” due diligence, before its investment, and is now exploring “legal options”.
Red flags anyone?
With these two pension funds alone, malinvestment cost Canadian pensioners US$245 million. Despite both asserting “extensive due diligence” processes prior to investment, it is self-evident that in both instances the checks and balances failed.
At the time of making the investment into Celsius, Caisse chief technology officer described Celsius as “the world’s leading crypto lender with a strong management team that puts transparency and customer protection at the core of their operations”. Around a year later, Celsius is now bankrupt and its founder Alex Mashinsky reportedly withdrew US$10 million from the platform before it went belly-up.
In the case of the Ontario Teachers Pension Plan, the investment into FTX is arguably even more puzzling as the sheer scale of poor (if not completely absent) corporate governance has slowly come to light in its bankruptcy proceedings.
It’s worth clarifying that many superannuation funds have private equity investments – namely, investments into companies – within their portfolio. That in itself isn’t unusual as each fund’s mandate specifies the types of investments, sectors, level of risk and allocation permitted.
The question isn’t then whether the Canadian pension funds were permitted to invest in the crypto companies – they were. Instead, the primary issue is one of due diligence. Did they do enough homework to make sure they understood all the risks of the investment? On the face of it, no.
Aussie super funds slow on crypto adoption
The notoriously conservative superannuation fund industry has been slow to adopt crypto, citing a lack of regulation and volatility.
A spokesperson for Rest Super recently told AsianInvestor it was “interested in the wider impacts of blockchain technology and its role as a disruptor”, but that it wasn’t considering exposure at the moment. They did however add that the firm would “continue to assess how these assets are performing and the role they may play in our long-term strategy”.
State Super chief executive John Livana said that his fund wasn’t investing in crypto partially because it didn’t have “any intrinsic value” and in general, his fund wouldn’t invest in crypto anyway due to challenges associated with an emerging asset class.
He did however caveat his comments, saying that the fund was examining the “uses of the underlying blockchain technology” and was interested in “the concept of distributing property rights through NFTs”.
These sentiments are broadly shared by the superannuation funds for the most part, which roughly translates to – “we like blockchain, but we’re not sure about crypto”. And perhaps that makes sense. They want to stay away from specific digital assets for now, but what about investing in companies in the space?
Often when investors wish to gain exposure to an emergent asset class, they adopt a picks-and-shovel approach. Rather than trying to buy the underlying asset, this strategy instead looks to invest in companies who are operating in the space and would benefit from increased levels of adoption. In crypto, the equivalent is investing in companies (such as exchanges, wallets, miners and the like) and not the specific assets themselves.
To date, we haven’t seen any formal announcements from the Aussie superannuation sector of gaining exposure to crypto, even through the ‘picks-and-shovel’ play. However when that time comes, what are some of the key things it ought to do to minimise the prospect of dropping the ball?
Possible lessons for Aussie super funds
Until Australia has exchange traded funds (ETFs) offering exposure to crypto, superannuation funds are likely to remain on the sideline. In the interim however, there is still the possibility of them considering an investment in crypto companies as part of a ‘picks-and-shovel’ approach. The complete failure of both crypto investments by the Canadian pension funds discussed earlier could shed light on what they can do to minimise the risk of calamity.
The core lesson to be learnt here is undoubtedly one of due diligence. Nothing should be assumed — if anything, one should employ additional measures beyond standard protocol to make sure all is above board. Much like any company, Aussie super funds looking to invest ought to dig into the company structure and corporate governance, which in the case of FTX was “worse than Enron”. FTX didn’t even have a board of directors and somehow received billions in funding.
The issue of proper due diligence cannot be overstated as it is one of the most obvious themes arising from the FTX implosion. In a recent episode of Blockworks Macro podcast, the issue of venture capitalists (VCs) dropping the ball was tackled head on. In short, it was argued that it is “an open secret” that VCs often piggyback on the due diligence of others, thereby reducing their level of scrutiny and independent thought.
Another possible lesson from the Canadian pension funds’ fail can be classified as ‘begin by dipping your toes in when you’re investing outside of your core competency’. In other words, if you’re going to be moving into a sector that is largely new and unfamiliar, it makes sense to begin by gaining exposure to regulated, public crypto companies – whether that is an exchange such as Coinbase, Bitcoin miners such as Riot or even Michael Saylor’s MicroStrategy.
OTPP jumped in with both feet into a private unregulated offshore exchange with an incredibly opaque and complex tax structure. This was clearly reckless and an irresponsible allocation of capital, not because it lost money (that can always happen), but because there were so many red flags to those who did the work to understand the investment.
At this time, there’s little indication of any Australian super funds making an allocation to crypto assets or crypto companies. However, once proper regulation and consumer protection is in place, that may well change. In the interim, Aussies wanting crypto exposure in their super have to settle for the self-managed super fund route – a rather costly affair with significant regulation and compliance attached.
As Aussie super funds remain on the sidelines, they would do well to study the errors made by the likes of Caisse, the OTPP and VCs who found themselves licking their wounds for making what turned out to be terrible investments that were largely avoidable had a reasonable degree of due diligence been undertaken.