In the wake of the recent announcement that a public pension plan invested $25 million in digital assets, some industry analysts believe that high levels of exposure to volatile cryptocurrency could be cause for concern.

The Oct. 21 purchase was made by the $5 billion Houston Firefighters Relief and Retirement Fund (HFRRF) in partnership with bitcoin company NYDIG. It was touted in a release as the “first announced investment in digital assets by a public pension plan in the United States.

“We are excited to take this first step forward into the world of digital assets,” Ajit Singh, HFRRF’s chief investment officer said in a statement. “We have been studying digital assets’ transformative potential for some time and we are pleased to have a partner…[NYDIG]…to ensure secure, robust and efficient execution, and enhanced compliance as we enter this new market.”

NYDIG manages the private customized fund through which HFRRF made the investment.

Created in 2009, Bitcoin is a decentralized digital currency that allows direct sale and exchange without an intermediary. Ethereum, launched in 2015, is a decentralized blockchain platform.

Marc Joffe, senior policy analyst at Reason Foundation, said that “overall, cryptocurrencies have been highly volatile since their inception.” Additionally, Joffe pointed out that cryptocurrencies are not income producing assets.

“Unlike bonds, cryptocurrency holdings must be partially liquidated to provide income to beneficiaries,” Joffe explained.

That, and as Joffe described, other “unique risks such as losing the password used to secure the digital wallet in which virtual assets are stored,” are important considerations for public pension funds looking to invest in digital assets.

”Pension funds are typically more conservative, risk-averse investors relative to other segments,” said Christine Sandler, head of sales and marketing at Fidelity Digital Assets.

“They tend to look to allocate to investment vehicles that have exhibited long-term growth and low volatility, and these nascent assets have both a shorter history and more volatility than other traditional assets.”

A 2021 Fidelity Digital Assets study found that 73% of respondent U.S. pension funds, defined benefit plans, endowments and foundations, cited volatility as the top barrier to adoption.

Despite that finding, Sandler said, “we’ve seen increased interest from pensions. In fact, we’re seeing this uptick among all institutional segments.”

According to Sandler, that interest reflects the “growing sophistication and institutionalization of the digital assets ecosystem, combined with a strong macro narrative driven by response to the pandemic.”

Joffe pointed to recent expansionary fiscal and monetary policies, and said that in this current inflationary environment, portfolio managers might see digital assets as a reasonable investment alternative.

“Established cryptocurrencies appear to be supplanting gold as an inflation hedge,” he said. “Thus, they may be a reasonable alternative for portfolio managers concerned about the risk of the federal government and Federal Reserve being unable or unwilling to control inflation.”

Thomas “Tom” Aaron, vice president and senior credit officer at Moody’s corporation, said that “U.S. public pension systems invest in numerous types of assets, heavily concentrated into equities and alternatives.”

“These are in support of annual investment returns targets that are often around 7% in a market environment where high-grade fixed income interest rates remain below 3%,” Aaron explained.

Aaron said that those asset allocations “expose many sponsoring state and local governments to investment volatility risk via their pension funds,” and that Moody’s incorporates that risk into its bonds ratings.

However, “in the specific case of Houston’s firefighter pension system, the reported purchase of $25 million of crypto currency is relatively minor in comparison to the system’s more than $4.1 billion of assets reported as of June 30, 2020,” Aaron said. Since June, that asset base has grown as a result of fiscal year investment returns.

Joffe agreed that the $25 million cryptocurrency investment–which amounts to “about 0.5% of HFRRFs total assets under management,” is minimal relative to the size of the fund.

”So the risk to the overall portfolio is limited,” Joffe acknowledged. But “that said, if the fund significantly increases its exposure to this risky asset class, there could be cause for concern,” he added.

Joffe also noted that HFRRF reported an assumed rate of return of 7.25%, which is “slightly above the median for large [pension] plans.”

“Lowering the assumed rate of return and thus increasing actuarially determined pension contributions would reduce pressure on investment managers to “reach for yield” by embracing risk assets such as Bitcoin and Ethereum,” Joffe said.

While HFRRF is thought to be the first U.S. public pension fund to announce this kind of allocation to digital assets, public pension funds have, in recent years, reportedly sought approval to invest in investment funds that buy cryptocurrencies.

“Institutional investors we surveyed have indicated a greater propensity for digital asset investment products than direct ownership of cryptocurrencies,” Sandler said. “From our study, we also know that pension funds and defined benefit plans favor active management of an investment product containing digital assets.”

That said, it is unclear at this point whether public pension funds will increase investment in cryptocurrency going forward.

It’s “difficult to know based on one data point,” Joffe said, adding, “the Fairfax, (Virginia) systems bought into a blockchain venture capital fund, which is very different.”

In 2018, the Fairfax County Police Officer Retirement System (PORS) and the Fairfax County Employees Retirement System (ERS) both in Virginia, invested in blockchain technology.

ERS invested 0.3% of its holdings for a total of $10 million, and PORS invested 0.8%, which amounted to $11 million.

Jeff Weiler, executive director of Fairfax County Retirement Systems said in a statement on the county’s website, that “these investments were deliberately sized to be a small portion of each system’s assets, given that the blockchain technology industry is still in its early stages.”

Sandler said that pension funds’ negative perception of digital assets will decrease as “the market continues to mature and investors get more comfortable with the technology.”

“Most investors go through a three-phase journey,” Sandler said. “Getting educated to forming an investment thesis to operationalizing. And we’re seeing more and more pensions at least starting to have the conversation and deepening their education in the space, which is a positive trend.”