Portfolios can benefit from holding crypto assets as they provide exposure to high Shapre ratio assets plus portfolio diversification.
Read on to learn more about crypto assets in the context of Portfolio Theory.
Monetary Policy and a Very Successful Investment Decade
The past decade has been one of the most successful investment decades in history: US stocks rose by an average of 248%, the US real estate market by 200%, and gold as a “safe haven” climbed by 40%. The loose monetary policy as a result of the financial crisis has certainly contributed a great deal to this trend. As alternatives such as saving accounts or life insurance are simply no longer an option in times of low-interest rates and increased monetary supply. The two graphs below illustrate this phenomenon very well.
Even today, in the times of the corona crisis, the rally seems to have no end.
But where else should money flow?
Crypto Assets As an Allocation — Why?
Savvy investors now know that Bitcoin was the best investment of the last decade and that crypto assets are the fastest growing asset class today.
Nevertheless, the question arises whether it is worth the risk an investor has to take based on its volatility and other factors.
Having already written about the best way to invest in crypto assets and their distinct value drivers today’s topic is: Does it make sense from a portfolio theory point of view to include crypto? Why do star investors and billionaires like Mike Novogratz, the Winklevoss twins, or Paul Tudor Jones talk so enthusiastically about this asset class?
The answer lies in the Sharp ratio.
The Sharpe Ratio takes into account not only the performance but also the fluctation margin (volatility) of a portfolio and puts the two variables into perspective. It thus indiucates how much return a portfolio offers per unit of risk.
The higher the Sharpe ratio, the more the portfolio compensates for the risk taken.
As a Chartered Alternative Investment Analyst (CAIA), I wanted to find out what effect an allocation of crypto has on different types of portfolios, such as the Norway model, the Family Office model, or the Endowment Model. It was important not only to look at the increasing alpha (obviously, considering that this is the best performing asset in recent years) but to focus especially on the Sharpe Ratio and thus on the beta (systemic risk).
Which Types of Portfolios Benefit Most from Crypto?
In short, each portfolio benefits from an allocation, not only in terms of performance (alpha) but also in terms of the risk/return ratio, measured by the Sharpe Ratio.
This is particularly astonishing considering that this is a highly volatile asset class. Volatility is punished in portfolio theory and it takes quite a bit to increase the Sharpe Ratio. It is only through this increase that an asset legitimizes itself as an addition to a balanced portfolio.
Family offices and pension funds benefit most from a 5% allocation of crypto assets in their portfolio. The Sharpe Ratio for a pension fund doubles and that of a family office even increases by 180%, which is almost triple. The increasing performance, the additionally generated alpha, is well illustrated by the following graph:
The annualized performance of the respective portfolios would even have quadrupled or quintupled in this period. And that is only with a 5% admixture of a crypto index.
So, what are our conclusions?
- Investing part of your assets in crypto assets makes sense from a portfolio theory perspective. And not only in terms of performance, but also in a risk-return context.
- Excessive money printing seems to continue to fuel the markets as there is a lack of alternatives. Stocks and real estate as well as crypto assets benefit from this.
- Crypto assets are a distinct asset class, As such, also due to their low correlation, they should be at least a minor component of any portfolio
- “The greatest risk of crypto assets is not owning any”
- A Beginner’s Guide to Crypto Investing
- Correlations in Portfolio Theory
- The Impact of Crypto Currencies on the Sharpe Ratio of Traditional Investment Models
- Investigating the Myth of Zero Correlation Between Crypto Currencies and Market Indices
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