How Bitcoin exposure ‘reduces risks’ in traditional portfolios

Bitcoin benefits investment portfolios through risk reduction despite long-held views in financial circles about the viability of cryptocurrencies in conservative investment strategies.

If investors allocate just 1% to Bitcoin in a traditional portfolio normally made up of 60% equities and 40% bonds, it can markedly improve its overall performance, according to a report from K33 Research on Tuesday.

A 1% Bitcoin allocation would reduce equities and bonds allocation by 0.5%, respectively.

The findings suggest that such a blend not only withstands market volatility, but also surpasses the performance of the conventional model by 3.16%.

The report also cautions that while a modest Bitcoin investment can enhance a portfolio’s performance, significant exposure can introduce greater volatility and risk.

“Size allocation is a matter of taste and risk appetite,” Vetle Lund, a research analyst at K33, told DL News.

“Returns outpace excess volatility, but the enhanced volatility is a clear disincentivising feature for conservative savers,” Lund said, referring to the typical investor building a 60/40 portfolio.

Other factors beyond volatility could affect investors’ decisions to allocate Bitcoin to portfolios.

“Liquidity plays a part, volatility plays another part, and so do correlation regimes,” Lund told DL News.

Liquidity refers to the ability of market participants to execute buy or sell orders close to the prevailing market price.

In low liquidity markets price moves can be exacerbated by a smaller number of trades, which can make investments in these markets less desirable.

Bitcoin’s liquidity conditions have been slowly recovering after the collapse of crypto exchange FTX last year.

Changing landscape

Bitcoin allocations to portfolios also boost diversification. While Bitcoin has gone through periods of extreme correlation with equities in the past, signs suggest that could be changing.

“Bitcoin has [returned] to a somewhat unpredictable path, independent of macroeconomic factors,” K33′s report said.

“This has implications as Bitcoin again shines as a powerful portfolio diversifier,” it added.

The previously observed correlations between traditional assets and Bitcoin dissipated as the cryptocurrency rode the wave over potential approval of spot Bitcoin-based Exchange-Traded Funds.

Bitcoin became negatively correlated with major US stock indices like the S&P 500 and the Nasdaq composite between mid-September and mid-November, according to data from The Block Research, as spot ETF approval looked increasingly likely.

Spot Bitcoin ETFs are poised to appeal to conservative investors, offering a viable option to bolster the risk profile of their long-term savings portfolios.

The US Securities and Exchange Commission will start approving spot Bitcoin ETFs in the near future, Bloomberg Intelligence ETF analyst Eric Balchunas told DL News on Monday. He expects approvals by mid-January.

ETFs represent Wall Street’s gradual acceptance of crypto, Balchunas added.

“These worlds have been trying to connect for 10 years. And they’re just getting so close, they’re like right there,” he told DL News.

As these two worlds collide and ETFs simplify access to Bitcoin exposure, K33 expects “diversification and risk-adjusted outperformance to be key go-to-market strategies” for asset managers.

Entry point

Fidelity Digital Assets, the crypto arm of the $4.5 trillion asset manager, shared similar sentiment in an October report.

Furthermore, Bitcoin offers a better risk versus return trade-off than other cryptocurrencies, Fidelity said. It should be considered an entry point for “traditional allocators.”

“Bitcoin’s return profile is driven by two strong tailwinds,” Fidelity analysts wrote, namely the global growth of the digital asset space and the potential instability of traditional macroeconomic conditions.

“These Bitcoin return tailwinds are likely to be captured in an easier way with less risk than via the majority of other digital assets,” the report said.

Over two thirds of current institutional investors expect to increase allocations in cryptocurrencies in the next three years, a recent survey by Coinbase Institutional research found.

Another 45% of institutional investors surveyed without crypto allocations expect to allocate in the next three years.

Ekin Genç is a Managing Editor at DL News based in Oxford. Adam Morgan McCarthy is DL News’ London-based Markets Correspondent. Got a tip? Reach out at ekin@dlnews.com or adam@dlnews.com.