Bitcoin Investing: Diversification Tool for Multi-Asset Portfolios

Bitcoin Investing for Multi-Asset Portfolios

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Bitcoin investing has had its ups and downs during its more than ten years of existence, but the cryptocurrency has matured and is ready to add value to non-crypto portfolios by acting as a great diversification tool. The main benefit of Bitcoin is that it shows little correlation to traditional stocks, even though the level of correlation to stocks and gold has increased since the pandemic. Besides this, the cryptocurrency is liquid, and one can easily get exposure through derivatives like futures.

Binance Futures is the best exchange where you can buy and sell Bitcoin futures without actually dealing with physical cryptocurrency.

Bitcoin investing has become one of the most lucrative alternative assets to be considered in multi-asset portfolios thanks to its diversification capabilities.

About two years ago, Aleh Tsyvinski – an Economics Professor at Yale University – recommended that a portfolio had at least 6% in Bitcoin. While this percentage may vary from investor to investor, allocating a small share of your portfolio would result in better return potential in most cases, since the cryptocurrency is scarce and its price is gradually rising together with demand. Bitcoin’s diversification properties are relevant, especially amid the current global crisis triggered by the coronavirus pandemic and the consequent lockdown measures.

Volatility in Bitcoin Investing

Before getting exposure to Bitcoin, you should understand that Bitcoin investing demonstrates high volatility that is not comparable to foreign currency pairs or stocks. This is important to comprehend, especially if you plan to buy Bitcoin futures on margin.

The price of Bitcoin started at less than $1 in the 2010s and surged to $20,000 seven years later. It then tumbled below $4,000 in 2018 and again in March 2020, bouncing back to over $10,000. Hence, you can expect everything from the cryptocurrency. However, the important thing is that Bitcoin has had higher lows to this day, suggesting that the long-trend is bullish.

The most lucrative year in terms of return on investment (ROI) was 2013 when the king of crypto surged over 5,400%. However, that kind of ascension is definitely not possible amid current market capitalization of about $210,000 billion. Still, no one would be surprised if Bitcoin doubles or even triples in price at some point. Some expect the value of the cryptocurrency to reach a six-digit figure in the next five years.

Here is Bitcoin’s monthly realized volatility according to Skew data:

Bitcoin’s Monthly Realized Volatility - Bitcoin Investing
Bitcoin’s Monthly Realized Volatility

The volatility level surged to the highest level since 2014 in March, when the cryptocurrency nosedived following the stock market crash as a result of the pandemic and the consequent lockdowns. Even though Bitcoin’s volatility is appeasing, it’s still much higher compared to stocks, gold, and other traditional assets. The cryptocurrency’s volatility is possible due to the following factors:

  • Bitcoin is a new asset, and the technology underpinning it – blockchain – is still at a nascent stage. Given that the price of Bitcoin started at zero, it is natural that it will fluctuate wildly until finding its fair position in the global economy.
  • The market has been dominated by retail investors – since its launch, the crypto industry has been driven by retail traders and investors, who rotate positions more frequently compared to institutions.
  • Lack of proper infrastructure – at the beginning, Bitcoin trading relied on peer-to-peer environments, which couldn’t foster a rapid adoption at a global level. Once more crypto exchanges came out, including decentralized venues, the liquidity has increased, and the volatility level might drop.

Bitcoin Correlation to Traditional Assets

Besides volatility, another important aspect that portfolio managers should consider is Bitcoin’s relatively low correlation to traditional assets, even though the correlation figure has increased since the pandemic. In fact, correlation is the first thing investors consider when diversifying their portfolios.

When two different assets move in the same direction in a given period, they are considered to show some correlation, and thus share similar risks. Investors who are looking not to hold all eggs in a single basket would be interested in dispersing those risks among very different types of assets, potentially with inverse correlation. In the latter case, the negative correlation implies that one asset can be used to hedge against the other.

Recently, Binance Research used Bloomberg data to measure the correlation of Bitcoin in relation to stock indexes and commodities. Here is the chart representing the three-year weekly return correlations among the analyzed assets and indexes:

Bloomberg Bitcoin Correlation to Stock Indexes and Commodities
Bloomberg Bitcoin Correlation to Stock Indexes and Commodities

The abbreviations stand for the following:

  • SPX – S&P 500 index: it tracks 500 of the largest public companies in the US.
  • RTY – Russell 2000 index: it tracks US small-cap and mid-cap companies, whose shares are often called penny stocks.
  • CCMP – Nasdaq: the index tracks the companies listed on the Nasdaq stock market, which is mostly made up of tech stocks.
  • LEGATRUU – Bloomberg Barclays Global Aggregate Index (USD): it tracks the performance of the most important government and corporate bonds.
  • LBUSTRUU – Bloomberg Barclays US Aggregate Index (USD): it measures the USD-denominated, fixed-rate taxable bond market open to investors. It comprises Treasuries, mortgage-backed securities, asset-backed securities, and more.
  • CL1 – Crude oil futures price as traded on the NYMEX.
  • GC1 – Gold futures prices as traded on the COMEX.
  • SI1 – Silver futures prices as traded on the COMEX.
  • BCOMTR – Bloomberg Commodity Index Total Return: it tracks the prices of several commodities.
  • TPX – TOPIX Index: it tracks Japanese stocks.
  • HSI – Hang Seng Index: it tracks Hong Kong Stock Exchange-listed companies.
  • SX5E – EuroStoxx 50: it tracks 50 of the largest European companies.
  • UKX – FTSE 100: it tracks 100 of the largest companies listed on the London Stock Exchange.

As you can see, Bitcoin has shown some volatility with the European and British stocks, but that is so minor that it can be neglected.

However, it has to be mentioned that the correlation to the US stocks increased in the last few months. When the stock market crashed in mid-March amid the start of the pandemic and lockdowns, Bitcoin lost over half of its value within two days. Since then, the cryptocurrency recovered, and so did the US stock market. The correlation between the S&P 500 index and Bitcoin reached an all-time high in July and then almost updated it in September.

Bitcoin S&P500 Realized Correlation
Bitcoin S&P500 Realized Correlation

As the effect from the pandemic fades, the two markets will definitely take different routes, as Bitcoin investing is driven by completely different fundamentals.

Portfolio Management Simulations with Bitcoin Investing

Binance Research has conducted a series of portfolio management simulations to figure out how efficient Bitcoin is at diversifying a multi-asset portfolio.

For those unfamiliar, diversification is a risk management technique in which a wide range of investments are mixed within a portfolio to disperse risks. The return of such a portfolio tends to be higher long-term, even though they can lag behind investments with short-term targets. The main goal of diversification is to reduce risks by allocating capital to uncorrelated assets. Since Bitcoin shows almost no correlation to any traditional asset, it should be a good candidate for a multi-asset portfolio. The latter cover multiple asset classes, including foreign currencies, stocks, exchange-traded funds (ETFs), bonds, and alternative investments such as property.

Binance Research analyzed the two largest investment management companies – BlackRock and Vanguard – and separated their largest ETFs. It then took these ETFs and incorporated Bitcoin investing into the funds for the simulation based on the following methods:

  • Time-Based Rebalancing – it consists of a portfolio rebalancing that occurs at fixed, predetermined intervals. For example, Bitcoin’s weight is regularly re-allocated on a monthly basis with different levels of exposure, including 1% and 5%.
  • Dynamic Boundary Rebalancing – the rebalancing, in this case, happens whenever the effective portfolio weight of Bitcoin is either below a specific threshold (for example below 2.5%) and above a specific threshold (like above 7.5%).

Bitcoin transaction fees were included in both cases while the price slippage was not considered, though it should be taken into account for very large transactions. The rebalancing process is carried out by selling the ETF and buying BTC or vice versa, depending on the BTC weight deviation from the target.

The chosen ETFs for the simulation were iShares Morningstar Multi-Asset Income ETF from BlackRock and VPGDX from Vanguard. The former allocates 60% to bonds, 20% to stocks, and 20% to alternative income sources. On a side note, BlackRock’s total assets under management surged to a record $7.8 trillion during the third quarter of 2020, so you can understand the immense size of the asset manager.

VPGDX allocates 55% to stocks, 20% to bonds, and 25% to alternative assets.

For both ETFs, all the distributed payouts are reinvested right away to measure performance accordingly. Now here is the interesting part of results:

Time-Based Rebalancing

In the first method, Bitcoin was allocated with various target weights into a multi-asset portfolio. In total Binance Research analyzed four model portfolios with this rebalancing method. Specifically, for each ETF the Bitcoin weight was set at 1% and 5%. The resulting 4 model portfolios were rebalanced in the last trading session of every month to maintain the target weight (of 1% and 5%). The period of the study ranged from the last day of 2015 to June 30, 2019, which is exactly 3 years and 6 months. Here are the aggregated results:

Bitcoin Portfolio - 4 Model Portfolio Rebalanced
Bitcoin Portfolio – 4 Model Portfolio Rebalanced

As you can see, the model portfolios that incorporated Bitcoin performed better in all cases versus the portfolios without Bitcoin. In the case of allocating 5% to BTC, the performance improved by as much as 30% for the study period.

These figures speak for themselves, and some investors understand the potential of Bitcoin when it comes to hedge against traditional asset risks. Here is another way to look at it – the chart below shows the performance of the three versions of BlackRock’s ETF-related model portfolios:

BlackRock ETF Model Bitcoin Portfolios
BlackRock ETF Model Bitcoin Portfolios

A similar chart is displayed by the VPGDX-related models. Here is the calendar of returns for monthly rebalanced portfolios: VPGDX-Related Bitcoin Models

VPGDX Bitcoin Models
VPGDX Bitcoin Models

As you can see, with the exception of 2018, all Bitcoin-related model portfolios saw better returns than those without the cryptocurrency.

Dynamic Boundary Rebalancing

When using the second method, the results were relatively similar. Binance Research simulated the same 4 models, with Bitcoin’s weight of 1% and 5% for each ETF. However, at this time the model portfolios were rebalanced only if at the closing session the BTC’s weight went below 0.50% or above 1.50% in the case of 1% BTC target weight, and if the weight went below 2.50% or above 7.50% in the case of 5% BTC target weight. The period of study was the same, and here are the aggregated results:

VPGDX-Related Bitcoin Models
VPGDX-Related Bitcoin Models

Again, the model portfolios with Bitcoin investing performed much better than the actual ETFs that didn’t have the cryptocurrency. Also, the dynamic charts and calendar of returns are looking similar to the previous subset of portfolios.

It’s worth mentioning that the analysis has some limitations, such as the chosen period, price slippage, and taxation costs. Still, as soon as Bitcoin shows little correlation to traditional assets, it remains an excellent diversification tool for institutional and retail investors.

Also, to avoid price slippage and taxation costs, investors can use over-the-counter exchange services or get exposure through Bitcoin futures. Binance Futures provides the best trading services for Bitcoin derivatives. The platform allows up to 125x leverage, though you should use high leverage at your discretion, given the risks.

Binance Research concluded in its report:

“As part of a multi-asset portfolio, Bitcoin provides diversification benefits for investors, irrespective of their preferred asset classes. In spite of its high (yet decreasing) volatility, a simple allocation to Bitcoin in a diversified portfolio consistently leads to improved risk/return profile for both retail and institutional investors, in line with modern portfolio and diversification theories.”

Indeed, Bitcoin’s diversification capabilities have been observed by traditional investors for a while, and many reputable hedge funds, asset managers, and venture capital firms are allocating more and more capital to cryptocurrency.

The same can be true about other high market cap cryptocurrencies, like Ethereum or Ripple, but they use to follow the general trend of the cryptocurrency market, and Bitcoin remains the first violin. 



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