Where Does Bitcoin Fit In Portfolios?

May 10, 2018

There’s still no bitcoin ETF on the market, but that doesn’t mean ETF investors aren’t contending with the notion of whether bitcoin—and cryptocurrencies in general—belong in an asset allocation.

In an ETF wrapper, access to bitcoin today can only be achieved indirectly through some ETFs such as a pair of ARK Invest funds—the ARK Innovation ETF (ARKK) and the ARK Web x.0 ETF (ARKW)—that currently allocate less than 1% each to the Grayscale Bitcoin Trust (GBTC), a closed-end fund.

Still, Matt Hougan, global head of research for Bitwise Asset Management in San Francisco, and a well-respected expert in the ETF realm, recently penned a report arguing cryptos belong in a diversified portfolio. His work looked at the impact that a 1%, 5% and 10% allocation to cryptos would have on a 60/40 portfolio.

We spoke with Hougan, and two other advisors, about whether they thought cryptocurrencies belong in portfolios, and whether they’d add them to their asset allocation models.

Matt Hougan, Global Head of Research, Bitwise Asset Management; San Francisco:

The data suggest that adding a small amount of cryptoassets to your portfolio and rebalancing regularly can improve your risk-adjusted returns. Whatever you think about it philosophically, that's what the data show. Crypto has combined high returns with low correlations to other asset classes, which is a pretty good combo for portfolio construction.

There is every reason to believe correlations will remain low when measured over any meaningful time period, as the fundamental drivers of crypto returns are different than the fundamental drivers of stocks, bonds, etc. The right allocation for most investors is pretty small: You're talking about 1%, 2% or 5% at the outside. These are very volatile assets. But used correctly, they can be quite helpful in a portfolio setting.

John Davi, Founder & CIO, Astoria Portfolio Advisors; New York:

We strongly believe in the need for alternatives, commodities and hedge fund replication strategies within a multi-asset portfolio to help diversify traditional stock and bond risk factors. In our never-ending quest to find liquid, listed, transparent and tax efficient alternatives to hedge traditional stock and bond portfolios, we’ve examined the potential use of digital assets as a liquid alternative.

The pricing of digital assets resembles stock trading in the early 1900s or emerging market equities 20-30 years ago where spreads were wide, volatility was sky high and information flow was low. More knowledge, education, technology and more access to solutions should temper price volatility, but this will take time.

Some compare digital assets to gold, which has relatively higher intrinsic value compared to digital assets. Gold’s supply is elastic, whereas bitcoin is highly inelastic. These are important differences along with the fact that gold has a multiple-century head start compared to digital assets.

The “evidence” would suggest that they serve as a valuable portfolio diversifier if one were to incorporate a small allocation with strict rebalancing and risk management practices. However, one needs to temper this “evidence-based analysis,” given it can be challenging to account for bid/offer and transition costs, both of which are extremely high.

We get it: digital assets are uncorrelated. But what’s the point if it’s not accessible, execution costs are sky high and the liquidity profile is poor?

We hope the liquidity profile for digital assets improves. Equally important, as their liquidity improves, we hope their uncorrelated nature remains intact. However, one should realize liquidity and correlation tend to go hand in hand (more liquidity tends to result in higher correlation). Let’s see. 

Ben Lavine, CIO, 3D Asset Management; Hartford, Connecticut:

The intrinsic value of a cryptocurrency is inherently based on, first, its ability to solve digital asset transactions that don’t involve a third party, and, second, on demand for such transactions. From an investor’s viewpoint, cryptocurrencies exhibit similar characteristics to that of precious metals—the desire to hold an asset as a store of value independent of government-issued currencies.

We believe cryptocurrencies have more commercial applications for handling complex transactions and as a means of raising capital for venture projects than as investments held in broad asset allocation portfolios.

The private, anonymous aspect of cryptocurrencies is appealing, but also makes it a target for regulatory scrutiny. For cryptocurrency investments to become more widely adopted, the investment costs—custody, investment vehicles, management fees—must come down and there needs to be commensurate improvement in security, transparency and auditing.

Contact Cinthia Murphy at [email protected]

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