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Bitcoin is making headlines every day now. Others like to refer to bitcoin as gold 2. Meanwhile, the number of ways to invest in bitcoin is growing rapidly, as is the number of bitcoin exchanges.
All this underpins the notion that bitcoin is increasingly treated as a separate asset class. But what are its characteristics and how does it impact traditional investment portfolios holding equities and bonds? To get an idea, I first looked at some general features of traditional asset classes, like size, risk and return. At a price of USD source coinmarketcap. This is shown in the graph below, which is derived from the well-recommended research by Doeswijk, Lam and Swinkels on the value of the global multi-asset market portfolio.
The chart shows the investable market capitalization for major asset classes. For example, the total market value of global equities, ultimo , was approximately USD 42 trillion or 42 billion. This means that the market cap of equities is more than ! If bitcoin is added to the global multi-asset portfolio, it would have a weight of just 0. By the way, gold, which is not included in the global multi-asset market portfolio, has an estimated market cap of around USD 7.
More risk equals higher return. Long-term, this tends to hold for traditional asset classes. But what about bitcoin? The chart below shows the average annualized return of bitcoin and of traditional asset classes since July when bitcoin started trading on exchanges. Such a mind-boggling average return suggests that bitcoin is pretty different from traditional asset classes.
In addition, traditional asset classes can record pretty incredible short-term returns as well. So what about risk? Well, just look at the chart below. The Sharpe-ratio return divided by risk is often used as a measure to determine the attractiveness of an asset class. It reflects the amount of return per unit of volatility. As can be derived from the chart below, bitcoin scores extremely well on Sharpe. In general, a Sharpe ratio north of 1 is considered very attractive.
Within a multi-asset portfolio correlation is key. The table below shows the correlation between weekly returns on bitcoin and traditional asset classes. As may have been expected, since bitcoin comes with such extreme return and risk characteristics, the correlation is very close to zero.
There is no significant relationship between the returns of bitcoin and those of other asset classes. Worth noticing is that, while bitcoin is regularly referred to as a kind of digital safe haven or digital gold, the correlation between bitcoin and gold is also very close to zero. This suggests that gold and bitcoin are two very different creatures. Nor correlation, nor Sharpe can tell the whole story of how bitcoin behaves in a traditional multi-asset portfolio.
The available price and return data do, at least from a historical perspective. This may sound as a very minimal allocation, but the chart below reveals the opposite is true. If you created a multi-asset portfolio in July consisting of As you can tell from the graph these two portfolios are in no way comparable to each other.
That is, only if you did not rebalance your portfolio. Hence, adding a stringent rebalancing frequency prevented bitcoin from dominating the portfolio without giving up on the return potential due to the low correlation of bitcoin with other asset classes. Obviously, there is one caveat related to this strategy. The chart above does not take into account trading costs. Trading costs differ greatly between markets and investor types. But especially for retail investors weekly rebalancing is likely to significantly impact returns as they often pay a fixed amount for each transaction and make less use of derivatives.
In addition, trading bitcoin also comes at a cost and is far less straightforward than trading equities or bonds. Also one that is unlikely to be available for every investor. Second, bitcoin as an asset class comes with an extreme risk-return profile.
So, while its Sharpe ratio is way better than that of any other asset class, and the correlation with these other asset classes is basically zero, the sheer magnitude of both volatility and return should be taken into account. Which brings me to my final point, adding bitcoin to a traditional multi-asset portfolio requires a rigorous, and potentially costly, rebalancing scheme.
Still, this last example does show that for those who were able to rebalance at minimal cost bitcoin could have added value. You are commenting using your WordPress. You are commenting using your Twitter account. You are commenting using your Facebook account.
Notify me of new comments via email. Size To get an idea, I first looked at some general features of traditional asset classes, like size, risk and return. Click to enlarge Risk and return More risk equals higher return.
Click to enlarge So what about risk? Click to enlarge Sharpe The Sharpe-ratio return divided by risk is often used as a measure to determine the attractiveness of an asset class. Click to enlarge Correlation Within a multi-asset portfolio correlation is key.
Click to enlarge Portfolio Behavior Nor correlation, nor Sharpe can tell the whole story of how bitcoin behaves in a traditional multi-asset portfolio. Click to enlarge If you created a multi-asset portfolio in July consisting of Click to enlarge Obviously, there is one caveat related to this strategy. I own bitcoin Source: Twitter Facebook LinkedIn Email.
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