• Bitcoin lacks correlation with traditional assets over a multi-year basis while offering a high risk-adjusted return
  • The most inefficient portfolio is the portfolio with ZERO allocation to Bitcoin

To get the best results tomorrow, investors can’t apply more of what worked yesterday. Consistent with Modern Portfolio Theory, we generally subscribe to the notion the optimal return-to-risk ratio for a portfolio can be found on the efficient frontier. 

New asset classes are powerful because they offer a unique return stream that can provide a diversification benefit. In the below analysis we will show how Bitcoin with its return profile and additional volatility, offers considerable diversification benefits that can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns.

For this exercise, we will model the Blackrock Global Allocation Fund (MDLOX) over 3 and 5yr periods against 1%, 3%, 5% and 10% allocations to Bitcoin. The benefit of both periods is that it avoids selection bias by capturing the largest periods of drawdowns for Bitcoin on record.

Correlation With Other Assets

Despite its volatility, Bitcoin did not exhibit any significant correlation with other asset classes over the same period, with a median correlation coefficient with other asset classes around .26 over the 3 year time period. Irrespective of the study period, Bitcoin remains uncorrelated with all other non-crypto financial instruments and asset classes. 

Key Findings

Looking at the results above on both a 3-year and 5-year time basis, each portfolio benefits from an allocation to Bitcoin on both an absolute and risk-adjusted basis. Most notably, the optimal portfolios are the portfolios between 3% and 5% allocation to Bitcoin. When comparing returns over both the 3 and 5-year periods, it’s important to note that even with Bitcoin’s drawdown of almost 70% in 2018, portfolios are still better off with exposure to Bitcoin on both an absolute and risk-adjusted basis.

Over a 5-year period: 

  • A 1% allocation to Bitcoin increased annual returns by 325bps, with a slight uptick in vol of 49bps and an improvement in the Sharpe ratio of 32%
  • A 3% allocation to Bitcoin increased annual returns by 922bps, with a slight uptick in vol of 253bps and an improvement in the Sharpe ratio of 65%
  • A 5% allocation to Bitcoin increased annual returns by 1466bps, with an uptick in vol of 507bps and an improvement in the Sharpe ratio of 78%

Over a 3-year period, including the 75% drawdown in Bitcoin in 2018:

  • A 1% allocation to Bitcoin increased annual returns by 81bps, with a slight uptick in vol of 33bps and an improvement in the Sharpe ratio of 6%
  • A 3% allocation to Bitcoin increased annual returns by 240bps, with an uptick in vol of 120bps and an improvement in the Sharpe ratio of 17%
  • A 5% allocation to Bitcoin increased annual returns by 392bps, with an uptick in vol of 227bps and an improvement in the Sharpe ratio of 24%

The Bottom Line:

  • When observing the periods of the largest drawdowns, the portfolio with ZERO allocation to Bitcoin performed nearly identical to the portfolio with 1% allocation to Bitcoin. Impressively, the 5% allocation to Bitcoin experienced only an 1.2% additional loss
  • A 5% allocation to Bitcoin in the above 3yr and 5yr periods offered a standard deviation of 14.68% and 15.14% respectively vs the S&P average of 18.66% and 15.15%
  • The most inefficient portfolio is the portfolio with ZERO allocation to Bitcoin

Given Bitcoin’s lack of correlation with traditional assets over a multi-year basis while offering a high risk-adjusted return, it’s allocation in a traditional multi-asset portfolio offers strategic asset allocation benefits while helping investors build portfolios with higher risk-adjusted returns.  Based on the above analysis, even if you dislike Bitcoin or don’t understand it, data shows that zero exposure to Bitcoin at this point is the wrong allocation and that anywhere from a 1-5% allocation to Bitcoin will benefit investor portfolios.

For the other articles in this series please see:

Part 1: Financial Advisors Must Evolve and Allocate to Bitcoin

Part 3: How Do Financial Advisors Get Compliant to Buy Digital Assets?

  • Digital Asset Investment Management
    COO
    Adam Pokornicky is an Investment Advisor Representative and COO of Digital Asset investment Management, a licensed Registered Investment Advisor for Bitcoin and Digital Assets. Adam has over 18 years of Investment Management experience and has been invested in Bitcoin since late 2012. Adam writes the “New Money” newsletter and can be found on twitter at @callmethebear