Bitcoin was meant to be a modern-day peer-to-peer decentralized financial network, however, as it rose in the popularity, and its volatility decreased over the years even traditional wall street investors started showing interest. The longest crypto winter of 2018 was one of the main reasons for that change as it established Bitcoin as a viable investment option or a diversifier in the modern-day multi-asset portfolio.
Diversification is a risk-management technique where the investor invests in an array of different asset classes to minimize the risk. The aim is to reduce the risk which may arise from holding a single asset class like a bond, commodity or cryptocurrency. Thus investors create a portfolio of different asset-classes so that if one asset class is yielding negative returns, it can be minimized by other asset class.
Bitcoin has no correlation with other investment asset classes since it is relatively new, making it an automatic selection for investors to include it in their portfolio. Binance Research conducted a number of simulated tests to prove this and every simulated portfolio which had Bitcoin in their list showed a better risk-return profile than traditional multi-asset class portfolios. Thus, proving that Bitcoin is a better diversifier in the modern-day investment portfolio.
Simulated tests prove Bitcoin as the top diversifier
In their research, Binance analyzed top traditional investment management companies and selected the top 2 with the highest number of assets under management. Both firms were analyzed for their largest Exchange Traded Fund (ETF) with their multi-asset strategy. Each of these ETFs were then tested with the inclusion of Bitcoin in their asset portfolio through two methods namely time-based rebalancing and tolerance-based rebalancing.
The two Asset management firms selected for the test were BlackRock and Vanguard Asset Management and their respective ETFs were ‘iShares Morningstar Multi-Asset Income ETF’ and VPGDX |Managed Payout Fund. Blackrock ETF consisted of 60% bonds, 20% stocks, and 20% alternative income sources while Vanguard’s ETF consisted of 55% stocks, 20% bonds, and 25% alternative and other sources. All the payouts from the ETFs were reinvested immediately to calculate the performance. The target time period for the analysis was from December 31st, 2015 to June 30th, 2019
Bitcoin was added to both the portfolios and showed that it returned much better than other asset classes. For time-based rebalancing with a 1% target allocation of Bitcoin, the ETF would have generated an additional return of 5-6% over the 3.5 year study period. This means that including Bitcoin in the asset portfolio would have given the trader an extra annual return of 1.5%.
With a 5% target allocation of Bitcoin, the ETF would have generated a return of +59.3% and +57.2%, and without Bitcoin total returns of respectively +27.86% and +26.03%.
For tolerance based rebalancing, or dynamic rebalancing 0.5% – 1.5% Bitcoin allocations resulted in more than 8% additional returns. While 2.5%-7.5% allocation resulted in more than 14% annualized returns. Thus it is evident that no matter what kind of portfolio it is, the addition of Bitcoin has generated guaranteed returns.
The yearly return chart picture paints quite a similar picture
The study shows that as a part of the multi-asset portfolio, Bitcoin despite its high-volatility provides high diversification benefits for investors irrespective of the asset class they have invested in.