‘We are way ahead’: How Fairfax County bagged staggering crypto returns

Fairfax County Employees’ Retirement System’s allocation to digital assets has been its best-performing investment ever since the pension fund first dipped a toe in blockchain infrastructure and digital currencies and tokens as part of a new allocation to venture back in 2019.

Distributions from that inaugural fund investment are now starting to come in.

“We are way ahead,” Andrew Spellar, chief investment officer of the pension fund which manages $6.3 billion on behalf of public sector employees in Fairfax County, North Virginia, tells Top1000funds.com.

Today, the allocation has grown from an initial 1.5 per cent of the pension fund’s total assets under management to around 4.5 per cent, mostly because of the growth in value.

On a cost basis, the actual allocation currently stands at 2 per cent of assets (approximately $126 million), and Spellar adds that it won’t get any bigger despite his plans to re-up in the next cycle with the current roster of managers and deep conviction that blockchain technology will reshape financial services.

“Music is the best example of how everything has become digitised, and securities will reflect this too. I believe stocks and bonds will be tokenised and traded on a blockchain, as well as real estate and private equity so that private investments become liquid,” he predicts.

How it all began

Spellar dates his interest in the space to an eye-opening presentation by Professor Campbell Harvey, during which the prominent Canadian-American financial economist argued that blockchain would become the underlying infrastructure of the financial services industry in a transformation that was already being driven by the engineers and computer scientists flocking to the area.

A few conferences later, and one marketing call struck a chord. Spellar made a first investment in Morgan Creek’s inaugural Blockchain Opportunity Fund focused on private equity stakes in companies developing blockchain technology and the wider ecosystem.

Other investments in both private equity funds as well as limited investments (capped at between 15-25 per cent) in so-called Layer 1 liquid tokens like Bitcoin, Ethereum and Solana followed. Moreover, many of the private equity positions came with negotiated rights to tokens issued by the underlying companies.

“This way we ensured we didn’t lose the economic value by just investing in the equity if the company developed a token that becomes more valuable than the equity,” says Spellar.

Today, the bulk of the allocation is via private equity, although the pension fund also invested in high-yield, short-term fixed income investments that offered rates of return with low volatility. That strategy was a particular consequence of demand for capital because of a lack of access to traditional financing for digital assets at that time.

Fairfax wasn’t invested in FTX and had no stake in either the companies or funds that used it as a custodian in a close call that reflects the importance of manager relationships – particularly given that the pension fund has no say on what assets its managers buy, although it does have an LPAC seat that gives additional oversight on how the fund is managed.

Katherine Molnar, chief investment officer at $2.2 billion Fairfax County Police Officers’ Retirement System, a sister fund to County Employees’ and which also has an allocation to digital assets, tells Top1000funds.com: “Several of our managers looked at FTX; one manager passed on them three times and one six times. FTX was vetted by our managers and they, to their credit, decided not to invest.”

It’s not the only reason why strong manager relationships define success in the space. Spellar and Molnar also point out that partnering with managers early on has won their pension funds favourable terms. They have negotiated lower management, incentive and carry fees, and in some cases, tapped into revenue shares.

“As the manager grows, we have been able to profit from that as well and take advantage of being a reasonably sized partner in some of these funds,” says Spellar.

What about portfolio construction and risks?

Investing in digital assets requires thoughtful portfolio construction around correlation: like all tech investments, it is highly correlated to growth and the Nasdaq, and is not a diversifier from equity. The caveat is Bitcoin, which has slightly different characteristics like a store of value asset, which is why it’s sometimes referred to as digital gold.

Digital assets count as a high beta equity exposure and require sizing according to volatility, which is 50 per cent higher than the other venture capital Fairfax invests in, says Spellar.

Still, he presses again his underlying thesis that digital assets are not a new asset class and best seen simply as technology.

“If you own Microsoft, the reason the paper is valuable is because the underlying company develops and owns software. When you invest in digital assets, you own the software directly – it’s just a different way of thinking about owning the same thing.”

Custodian risk is another concern. Most institutional investors in liquid tokens use Coinbase and Anchorage Digital, the first federally chartered crypto bank in the US, as registered custodians because they have proven, resilient custodial arrangements.

But Spellar adds that custody of less liquid tokens, or tokens that have been issued by a company in which Fairfax has a private equity stake, does lead to self-custody issues. In the next phase, he predicts illiquid tokens will increasingly be tradeable whereby it will be possible to transfer tokens to Anchorage or Coinbase.

“The liquid exposure we have can be custodied by groups like Coinbase, Anchorage Digital or Fidelity Digital Assets, but when it comes to illiquid or early state tokens our managers have good processes that relate to the security of tokens. Our managers are hyper-focused on the topic,” adds Molnar.

Regulatory change is another risk given the impact policy shifts have on the sector.

Today, digital assets attract broad bipartisan support from the Republicans and Democrats, but it wasn’t always the case. President Donald Trump’s GENIUS regulation has made the environment more certain than it was under the Biden administration. “Digital assets were being pushed offshore; banks were reluctant to serve crypto-related businesses, and there was real effort to stymy innovation,” recalls Spellar.

Success also depends on transparency and stakeholder buy-in to ensure trustees and beneficiaries are on board. It took a while for Fairfax County’s beneficiaries to understand their exposure was via private equity and the fund wasn’t trading tokens. Board education sessions also explained the difference between Bitcoin and Ethereum; how an investment in Bitcoin compares to private equity, and why companies like Coinbase and Figure aren’t the same.

It also involves clear messaging around the amounts invested. Spellar explains that after FTX, people thought the pension fund had “lost billions of dollars” in Bitcoin, when in fact it only had $8.5 million (0.17 per cent) of its $5 billion assets invested in Bitcoin.

“Our holdings at the time were equivalent to a rounding error. It’s about making yourself available and encouraging people to ask us questions rather than post messages on Facebook. The team at Fairfax has maintained as much transparency as possible to the stakeholders of the Systems.”

Today, Spellar doesn’t believe blockchain faces the same valuation issues as overstretched AI. Although he does count multiple synergies between digital assets and AI – bots making financial transactions on blockchain would combine automation with track and trace transactions that would stop any opacity, for example.

He reflects that a scarcity of finance could crimp development of the sector like the “dry spell” in 2022 and 2024, but he is optimistic that innovation will happen regardless.

Molnar says digital assets, like any innovations, in early stages would feel “uncomfortable”.

“But we started out small, dipping our toes in to establish relationships with managers and get exposure in the same way we have in other high-growth areas because making small investments in innovation, is not a bad thing,” says Molnar.