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How much crypto, and what cryptos, might make sense as part of an investment portfolio?
With companies like Blackrock and Fidelity providing exposure to cryptos in their investment management platforms (see “BLACKROCK INVESTORS WILL GAIN ACCESS TO CRYPTOS VIA COINBASE PARTNERSHIP,” 9 Aug 2022), a much larger potential base of mainstream investing now has ready access to a custodial crypto option.
New research by Swiss-based Sygnum Bank Asset Management, the world’s first regulated Digital Bank, suggests that in the digital realm, Bitcoin is the crypto of choice to provide diversification.
According to the study abstract, four quantitative methods for optimal allocation to Bitcoin cryptocurrency within both alternative and balanced portfolios were tested, using “roll-forward” historical simulations.
Metrics included portfolio diversification, expected risk-returns, and skewness of returns distribution.
The study acknowledged the risks and difficulties of assessing the future investment potentials and yields of the emerging asset class:
“A challenging question remains about the optimal allocation to Bitcoin and, more generally, to a broad portfolio of cryptocurrencies given that returns of cryptocurrencies are characterized by high volatilities, changing correlations, and heavy tails of distributions.”
But, given that general precaution, the results of the study showed that all four allocation methods examined, produced a persistent positive allocation to Bitcoin in alternative and balanced portfolios.
It noted:
“We find that the median of optimisers’ average weights is 2.3% and 4.8% for 100% alternatives and for 75%/25% balanced/alternatives portfolios, respectively. We conclude that Bitcoin may provide positive marginal contribution to risk-adjusted performances of optimal portfolios. We emphasize the diversification benefits of cryptocurrencies as an asset class within broad risk-managed portfolios with systematic re-balancing.”
Study Aims To Prove Insights For Investment Fund Managers and Other Professionals
The Signum study is very much geared to providing insights to investment industry professionals, and is not meant as advice of any kind to retail and individual investors.
Still, its insights regarding bitcoin, which over the course of its 12 year existence, has seen startling volatility, an exploding ecosystem of digital assets and technologies, and growing awareness and uptake by the traditional financial sector, are worth examining.
As part of its analysis, the study analyzed marginal benefits of including Bitcoin to broad investment mandates with a multi-asset universe.
That multi-asset universe included things like Hedge funds, proxied using the performance data of HFRX Global Hedge Fund Index; Discretionary macro (SG Macro) hedge funds using SG Macro Trading Index; Systematic macro (SG CTA) hedge funds using SG CTA Index; and Gold, using SPDR Gold ETF (NYSE ticker GLD).
Within that framework, the study considered a generic portfolio allocation for the two types of investment mandates.
The first was an Unconstrained mandate, which targets absolute returns by investing into alternative assets. This mandate is typical for high net worth private investors and family offices.
The second was a Benchmarked mandate, which targets excess returns over a benchmark by allocating to a balanced equity/bond portfolio with additional overlay to alternative assets. Such a mandate is typical for institutional investors such as pension funds, insurance companies, and endowments.
The study was detailed and transparent regarding benchmarks and methods of allocation and analysis.
One interesting observation of the study was that although Bitcoin has become demonstrably more correlated with equities and bonds over the past few years than it was previously, the crypto’s correlation with returns on alternative assets has not changed significantly: “Thus, the allocation to Bitcoin is still viable within a diversified portfolio of alternatives.”
There’s much more to the study, including some very technical information, which can be viewed here.
But the conclusion takeaway was that bitcoin passed muster as an addition to investment portfolios:
“We present empirical evidence that it has been optimal to include Bitcoin to an investable universe for alternative and blended portfolios, using portfolio diversification metrics. Using roll-forward analysis with dynamic updates of portfolio inputs, we also find that adding Bitcoin has improved performances of optimal portfolios.”
“We conclude that adding Bitcoin, and more generally, a diversified basket of cryptocurrencies, to the investable universe of broad portfolios may be beneficial for both alternative portfolios and blended balanced/alternative portfolios. We emphasize the need for a robust portfolio allocation method with regular updates of portfolio inputs and re-balancing of portfolio weights.”