Analysis suggests modest diversification to cryptocurrency could lead to improved performance
The 2011 sports drama Moneyball told the story of how Billy Beane, the general manager of the Oakland Athletics, put together a winning team of baseball players that, based on traditional scouting methods, looked like unqualified losers.
While their potential for success wasn’t immediately clear (it would have been a pretty poor excuse for a movie otherwise), it was an unflinchingly contrarian look at historical performance that first hinted at the value each man could add.
In a similar fashion, a new analysis suggests that while the traditional balanced portfolio doesn’t pack quite the same diversification-driven performance punch that it used to offer investors, it could be improved with a small allocation to Bitcoin.
“They say that diversification is the only free lunch in investing,” wrote Julian Klymochko, founder and CEO of Accelerate Financial Technologies, in a new blog post. “By diversification, capital allocators are looking for assets with positive expected returns and low, or zero / negative, correlation to traditional asset classes such as stocks or bonds.”
Citing a landmark US$250-million investment in Bitcoin made by MicroStrategy, a publicly traded technology company with a $1.4 billion market capitalization, earlier this month, Klymochko noted that the cryptocurrency is increasingly being accepted as an investable asset class among institutional investors.
“This investment reflects our belief that Bitcoin, as the world’s most widely-adopted cryptocurrency, is a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash,” MicroStrategy CEO Michael J. Saylor said in a statement.
To evaluate Bitcoin’s promise as a diversifying asset class, Klymochko compared the past several years’ performance of a hypothetical 60/40 portfolio, with 60% exposure to the MSCI World Index of global equities and 40% to bonds via the MSCI Aggregate Bond Index. He performed the same calculations for a 59/39/2 portfolio with 59% stock exposure, 39% bond exposure, and 2% exposure to Bitcoin.
“Over the past three years, the investment portfolio with a 2% allocation to Bitcoin outperformed by 1.7% per annum with 70 bps of additional volatility, leading to a 22.1% improvement in risk-adjusted returns,” he said. Extending the comparison to five years, he noted, showed that the Bitcoin-spiked balanced portfolio outperformed by 2.2% per annum with just 50 basis points of added volatility, equating to a 33.2% improvement in risk-adjusted returns.
And while the past five years would have seen the traditional 60/40 portfolio produce a cumulative return just north of 30%, Klymochko calculated that a small 2% reallocation to Bitcoin over the same time frame would have resulted in a 44.5% cumulative return.
“Over the long-term, Bitcoin has had a 0.16 correlation to stocks and a 0.06 correlation to bonds, indicative of a very low correlation to traditional asset classes,” he said, adding that its five-year annualized return of 109% came with a Sharpe ratio of 1.27, compared to Sharpe ratios of 0.52 and 0.55 for stocks and bonds, respectively. “These investment characteristics represent the type of all-star performance that would make the asset a shoo-in for a diversified portfolio.”
