What to do of Bitcoin in 2019 with my diversified portfolio?Market Research - Jan. 2019

By David Lifchitz – Managing Partner, ExoAlpha, January 7th, 2019


Many people have been asking me lately what I think about Bitcoin and the crypto-currencies and if they should invest in them alongside their traditional stock and bond holdings.

In 2017, cryptos were a no-brainer, like the dot.com of 1999, but in 2018 they became the pariahs.

However, it’s worth taking a few steps back. Crypto-currencies are new investment instruments, with their own characteristics: highly volatile, hard to trade in size, require a special infrastructure to trade, but also have the potential of explosive returns.

When building a diversified portfolio, the emphasis has to be put on the correlation (or more precisely on the lack of correlation) of the underlying assets. If all assets are highly correlated, diversification will only limit the idiosyncratic risk of the underlying companies, but not the negative performance of the portfolio as all underlying assets act as one. Historically speaking, fixed-income instruments have been slightly negatively correlated with stocks, usually acting as a safe haven when stocks go down, making thus perfect sense to combine stocks and bonds in a diversified portfolio over time.

Back to cryptos and Bitcoin (BTC) (which I use in my analysis as the largest crypto by traded volume and market capitalization, but the same analysis also holds for the top coins by market capitalization). I’ve looked at Bitcoin over the last few years especially under the angle of correlation with stocks and bonds, using the S&P 500 Index as a proxy for stocks and the JPMorgan Corporate Bond Index as a proxy for bonds. The findings of this analysis are that Bitcoin has not been correlated to stocks nor bonds, making it therefore a potential good addition to a diversified portfolio from that point of view. But beware, uncorrelated doesn’t mean that adding Bitcoins to a diversified portfolio will prevent any downfall… Uncorrelated means that Bitcoin can move up when the stocks are up but can also move down, and vice-verse. Also, due to its high volatility, a passive allocation of BTC should be small in order to add value to the global portfolio over time.

We can also note that BTC returns have been, over the last five and half years (liquidity of Bitcoin prior to that doesn’t qualify it for a realistic investment in a diversified portfolio) always greater if not outright positive versus the ones of the S&P 500 when the index was in negative territory on a yearly basis, even in 2018 when the crypto bubble burst. However during positive days of the S&P 500, BTC has underperformed generally, except in 2017 but again that was an exceptional year for cryptos that may or may not come back any time soon.

Thus for example, a simple portfolio (“58-40-2”) holding 58% of Stocks, 40% of High Grade Corporate Bonds and just 2% of BTC rebalanced on a yearly basis, would have outperformed by 40% (9.6% annualized return vs. 6.9%) a classic portfolio holding 60% of Stocks and 40% of High Grade Corporate Bonds (“60-40”) without adding more risk (similar maximum drawdown (MaxDD)).

Going further, adding Bitcoin exposure to a global portfolio but in a risk-managed model designed to limit the downside of the Digital Asset, such as the strategies ExoAlpha has developed, reinforces the idea of adding Bitcoins to a diversified portfolio.

I have no idea where the S&P 500, Bitcoin nor the US 10Y will end the year, but building portfolios of truly diversified assets will remain the only free lunch on Wall Street also in 2019!

Happy New Year!


NOTE: This document does not constitute an investment proposal nor an investment recommendation in any form and should not be considered as such. Past performance is not a guarantee of future results.