How Pfeffer Capital Invests in Crypto

Why paying for top GPs' fees are better value than due diligence on direct deals

If you get a chance, you should definitely checkout the capital allocator’s podcast by Ted Seides. This one was of interest to me with John Pfeffer:

As noted on Ted’s site “John Pfeffer is an entrepreneur, investor and author of “An (Institutional) Investor’s Take on Cryptoassets.”  He is currently Partner of Pfeffer Capital.  In the 2000s, John was a Member at private equity firm KKR, and in the 1990s, he was Chairman of the Executive Board of leading French IT company Groupe Allium S.A. Before that, he advised on turnarounds while with McKinsey in Europe and Latin America. conversation jumps in the thought process and structure behind John’s family office portfolio, which combines building new businesses alongside fund investments in public equity, private equity and venture capital. We touch on common issues like active vs. passive, access, and fees, but from a very different insider’s perspective.

We then turn to his work in the crypto world and discuss his framework for incorporating crypto investing in a portfolio, conducting research in the space, defining the proposition for store of value and utility protocols, and valuing tokens and coins.

John was the first investor Ted has come across that has both done a deep dive into the crypto world andis neither all-in nor all-out.  He connects markets and economics with the complex ecosystem just simply enough that a layman like me can follow along.”

Themes & Manager Selection

Some things that he likes to explore is going deep on specific themes and seeing what is working and killing what isn’t. It is better to have several small seeds into investments, but there shouldn’t be more than 15% of a certain trend. There are certain edges that are exploitable, which allows to tolerate illiquidity & volatility.

On the public side, he is more of an indexer. In private equity, he is a big fan of leveraged buyouts where there are predictable cashflows to get several 100 basis points of returns. As a result of his time at KKR, he has a great network of GPs, which has allowed him to get great access to exquisite dealflow.

Working with GPs

The top GPs are good at risk management and managing returns. Low double digit returns are usually predictable. Most top GPs have a low risk of having impairment in returns. Driven by personal relationships, there have been mainly 5 organizations that he works with. The combination of relationships & great GPs are the key criteria. It is important to invest in venture to make money but also as a hedge. This hedge should also be profitable and an insurance premium. It helps to be in silicon valley, and since he is in London, it adds another layer. So this is why the good fortune of relationships with the early stage investors are very important.

Fees with Managers

We are usually paying fees with venture, but it is still a great asset class. When trying to do it yourself, there will be a lot of small checks and expenses in due diligence relative to the check sizes. At the end, you are paying less in the end since there is normally a low double digit net return on average with a top manager.

Cryptocurrencies

The invention of money in it’s utility is a ledger that keeps track of value that is transferred in exchange for things.  Bitcoin is an update to that, and since it’s a new technology it will most likely fail since it’s one of the first.  However, the newer blockchains will help to mitigate this as being part of the Web 3.0 stack.  Either way, Bitcoin is an asymmetric option, which could be big payout, but it if it fails it could go to zero.  With a longer investment horizon, it is important to have some asymmetric return options in a portfolio.  He is not certain about anything in life and is always open to adjustments/recalibration, but he still sees this as a long term investment like VC so that’s why it has a general allocation to the “venture capital” bucket alongside other technologies like genomics, etc...  There is a steep slope of expected return of time.  The delay of the entry increases the opportunity costs. It is important to read more than talk to people.  It is also important to be selective to who you talk to.  Each individual investment should be handled as a different risk.

Here are some additional interesting topics quoted from his paper:

“While tens or perhaps hundreds of billions of dollars of value will also likely accrue to the crypto assets underlying these protocols and therefore to investors in them, this potential value will be fragmented across many different protocols and is generally insufficient in relation to current valuations to offer a long-term investor attractive returns relative to the inherent risks. The one key exception is the potential for a crypto asset to emerge as a dominant, non-sovereign monetary store of value, which could be worth many trillions of dollars. While also risky, this potential value and the probability that it might develop for the current leading candidate for this use case (Bitcoin) would appear to be sufficiently high to make it rational for many investors to allocate a small portion of their assets to Bitcoin with a long-term investment horizon.”

Protocol Valuations

“You can’t value cryptocurrencies/protocols by discounting cash flows.  They are more considered currencies on a protocol in a closed economy.  One thing you can look at is the equation of exchange identity.  A given protocol is analogous to a simplified economy. The GDP of such an economy would be the aggregate cost of the computing resources necessary to maintain the blockchain, based on the quantity of processing power, memory and bandwidth consumed, multiplied by the unit cost of each. The token is typically the currency used to pay for those resources. The total network value is analogous to the money supply M (i.e., all tokens in issuance), where M = PQ/V; PQ (Price x Quantity) is the total cost of the computing resources consumed, V is a measure of how frequently a token is used and reused in the system (its velocity, V). The value of a single token is therefore M/T, where T is the total number of tokens.”

Store of Value

 “That brings us to the matter of quantifying the potential future value of the dominant store-of- value cryptoasset—and therefore the upside relative to today’s value. If a cryptoasset becomes a dominant non-fiat monetary store of value, a logical place to start in estimating its potential network value is as a fraction or a multiple of the value of the total stock of the current technology filling that role, i.e., gold, which has a total value of USD 7.8 trillion.  The question of what fraction or multiple to apply is more subjective. You may feel it will be hard or take a very long time for a cryptoasset to fully replace gold, which has been around for millennia, in which case you think it will be a fraction. Or you may argue that the technical advantages in terms of divisibility and portability in particular will mean that more of the world’s population will hold this cryptoasset than they do gold (anyone with a smartphone, a memory stick or a paper wallet can hold any quantity of a cryptoasset, but carrying and storing investment gold is more difficult). That cryptoasset, moreover, will likely play some role in payments while gold does not.”

Endowment Allocations in 2019

Bitgo released a great report which covers an overview of endowment allocations in crypto. which can be found here: https://www.globalcustodian.com/endowment-cryptos-survey/

  • 94% of endowments have participated in crypto investments in the last 12 months

  • 54% of these investments were direct, while 46% were through a fund

  • Only 7% believe their investments will drop in 2019

IMPORTANT NOTICE: This document is intended for informational purposes only. The views expressed in this document are not, and should not be construed as, investment advice or recommendations. Recipients of this document should do their own due diligence, taking into account their specific financial circumstances, investment objectives and risk tolerance (which are not considered in this document) before investing. This document is not an offer, nor the solicitation of an offer, to buy or sell any of the assets mentioned herein.