A Bitwise report indicates that the results depend on the application of an adequate investment strategy. Allocating more than 1% of the portfolio to Bitcoin could disturb the balance between risk and profit.
A proper management strategy almost always helps Bitcoin to increase the value of a combined portfolio. That happens even when buying it at all-time highs, according to a study conducted by Bitwise.
A test portfolio that employs historical data allowed the San Francisco-based asset manager to find interesting facts. For example, investors that assign a small portion of Bitcoin to a portfolio composed of stocks and bonds have seen a noticeable increase in cumulative returns, even in the last three years.
The Bitwise report, published last May 6th, jointly with research director Matt Hougan, indicates that an allocation of about 2.5% in Bitcoin in January 2014, with a quarterly rebalancing, could have increased portfolio returns from 26% to nearly 45% on March 2020. An allocation of 5% could have doubled the profit return of a traditional portfolio by up to 65% during the same period.
This is not entirely surprising as the price of Bitcoin has ranged from USD 750 to USD 6,500 in the past six years. Considering that Bitcoin was the best-performing asset of the past decade, investors could expect huge profit returns for holding something that witnessed a 766% price increase.
It is interesting to see that profit returns still increased, though only marginally. Even when Bitcoin was assigned to the portfolio, it was at the all-time high of USD 20,000 in December 2017. Besides, it remained at the same weighting as the portfolio until March 31st, even when the stock had fallen by about 66% to levels below USD 6,500.
In the same period, assuming a quarterly rebalancing, an allocation of 2.5% or 5% contributed to profit returns from 0.005% to 0.40%, to a portfolio of 60% in global stocks and 40% in bonds. Without any Bitcoin allocation, the value of the portfolio would have decreased by 0.54%. An allocation of more than 1% in Bitcoin would have led to a 0.51% drop in the overall value of the portfolio.
In the report, Bitwise explains that these seemingly paradoxical results stem from Bitcoin’s nature as an asset, which is highly volatile but largely uncorrelated with other assets.
This makes it ideal for the volatility harvest, which is a wealth management strategy that emerged just in 2012. During this process, rebalancing increases returns by extracting value from the main well-performing but volatile assets, such as Bitcoin, and anchoring the mined value to something more stable, like a first-class stock.
However, Bitwise explains that this depends on a disciplined and consistent rebalancing strategy. Those who balance very often suffer from lower returns, while those who only maintain and never rebalance significantly increase their risk of falling.
Bitwise found that, between 2014 and March 2020, with a 2.5% allocation in Bitcoin, a monthly rebalancing would lead to profit returns of just 38% and increase the reductions to 22.3%. In that case, the savings would have produced 42.1% profit returns but would come with a reduction of 32%. An annual rebalancing showed the best of both worlds, with cumulative returns of 67% and maximum reductions of only 22.3%, while the rest remained the same.
The asset manager also said that the accumulation of many bitcoins in a portfolio, with an allocation greater than 5%, would increase volatility to the point where the risk of reduction could begin to outweigh possible profits.
By Alexander Salazar