Bitcoin as an asset could help balance portfolios

Marc Faber, also known as “Dr. Doom” in the investment world, has long made a name for himself with his perpetually bearish outlook and his “Gloom Boom & Doom Report” newsletter. In recent interviews aired with Bloomberg and CNBC, the swiss investment advisor and fund manager repeated his claim that the US is most likely in a recession. He divulged his evidence for the abysmal state of the US economy, and hinted that Bitcoin is something that investors should be looking into.

“When you talk about doom and gloom for this year, 2016, I have to point out that in 2015, with the exception of people that held bitcoins, the performance of all asset classes has been poor."

• Marc Faber

Faber famously advised his clients to get out of the stock market altogether before the October 1987 crash, and made several warnings leading up to the 2008 banking sector problems. He has been famously wrong at times too, such as when he predicted gold prices would rise by 30% in 2015.

A confirmed goldbug, Dr. Doom hasn’t offered any bullish statements on bitcoin. However, this is not the first time Faber has referred to the digital currency. In 2014, Faber discussed bitcoin briefly in a webinar covering a variety of issues, including monetary policy, precious metals, and gold manipulation.

“I don’t know the value of a bitcoin. I own gold because when the system breaks down, I want to have some cash. With a bitcoin, there is a scenario where the system breaks down and you have no internet access and then what is the value of your bitcoin?”

• Faber in 2014

2014 was bitcoin’s worst performing year in history. Bloomberg View, the editorial division of Bloomberg News, published a story that bitcoin was “2014’s worst currency,” beating the Russian ruble and the Ukrainian hryvnia. However, at the end of last year Bloomberg View reported that bitcoin “won 2015.” So Faber is not alone in observing it’s remarkable performance.

Bitcoin is not only performing well compared to other currencies. As Fabor stated, it’s the best performing asset class as well, although looking ahead into 2016, Faber told Bloomberg that “asset markets will crash like titanic.” Everything is going to go down when there is a significant correction in the market, he said.

The idea that Bitcoin is an asset class, on par with stocks, bonds, precious metals, or currencies, was popularized by Max Keiser early in 2013, on his show the Keiser Report. In December 2013, TheBankwatch agreed, with the FinTech blog defining exactly why in “Bitcoin is an asset class, not a currency.” In May 2015, the NYSE launched a Bitcoin Price Index, and deemed it an asset class in the press release.

“Bitcoin values are quickly becoming a data point that our customers want to follow as they consider transacting, trading or investing with this emerging asset class.”

• Thomas Farley, NYSE Group President

One of the first things that all investors are taught about creating a strong portfolio is to own something from each asset class in it. Diversification is the hallmark of a good investment portfolio, and for years that meant keeping a range of stocks, bonds, and precious metals all side by side. Ideally, when one asset takes a hit, the others can compensate for the loss.

While there is no guarantee that Bitcoin will continue to outperform other assets, having bitcoin in an investment portfolio could be benficial. “The goal of diversification is not to boost performance,” states Fidelity Investments, the second-largest mutual fund and financial services group in the world. A good portfolio should be diversified with a variety of asset classes and “diversification may provide the potential to improve returns for that level of risk,” Fidelity wrote.

“To build a diversified portfolio, you should look for assets—stocks, bonds, cash, or others—whose returns haven’t historically moved in the same direction, and, ideally, assets whose returns typically move in opposite directions. This way, even if a portion of your portfolio is declining, the rest of your portfolio, hopefully, is growing. Thus, you can potentially offset some of the impact of poor performance on your overall portfolio.”

• Fidelity Investments

Since the goal of portfolio diversification is to choose asset classes that do not move in the same direction, bitcoin is a natural fit. It moved against other asset classes in both 2014 and 2015, being the worst performer one year, and the best performing the following year. While many markets are expected to underperform this year, investors may take notice of bitcoins already above average performance.

In 2013, Marie Brière, Kim Oosterlinck, and Ariane Szafarz of Paris Dauphine University wrote a research paper analyzing portfolio diversification with bitcoin. They found that bitcoin’s correlation with other asset classes is remarkably low. While they cautioned that bitcoin’s volatility was too high to be included in the lowest-risk portfolio at the time, they offer the opinion that Bitcoin investment offers significant diversification benefits: “Bitcoin rate of return presents statistical characteristics that differ markedly from those of other assets, including gold, oil, and hedge funds. In addition, Bitcoin investment is attractive because it delivers exceptionally high diversification benefits. This is due to low correlations not only with traditional financial assets but also with alternative investments.”

The volatility of bitcoin’s price has fallen steadily since that time. Today bitcoin’s 30-day price volatility sits around 3.17%, according to Btcvol, whereas 2013 was a famously volatile year in bitcoin’s history, containing the peaks from April’s “Cyprus rally” as well as the top of the Mt.Gox bubble at the end of the year.

While today’s 3.17% volatility estimate puts Bitcoin above the normal range for major currencies, the US dollars 30-day range is typically 1%-1.5% against other majors, the volatility for other currencies can be in the 25%-50% range, such as during the rapid devaluation of Argentina’s peso and Venezuela’s bolivar.

An independent research paper published by WU Vienna University of Economics and Business, Does Bitcoin Improve Portfolio Diversification?, makes a strong case for the argument that “Bitcoin should be included in optimal portfolios.”

The papers authors, Alexander Eisl, Stephan M. Gasser, and Karl Weinmayer, adopt a portfolio optimization approach built on Conditional Value-at-Risk (CVaR), to account for Bitcoin’s highly non-normal return distribution. They found that including Bitcoin in portfolios improved both the expected return as well as the risk of the portfolios. However, they clearly state that “the return contribution seems to outweigh the additional risks faced by the investor.”

“We find that even in already well-diversified portfolios our optimizations lead to Bitcoin being included in efficient portfolios with mean weights ranging from 1.65% to 7.69%. The relatively low and stable Bitcoin weights are also beneficial from a liquidity perspective…Bitcoin can contribute to the risk-return ratios of optimal portfolios.”

• Does Bitcoin Improve Portfolio Diversification?

In a recent report, “how to position for the rally in bitcoin”, Austrian economist and investor Tuur Demeester echoed the sentiment, “it is important to use Bitcoin as part of a diversified portfolio.” He also explains the benefits of bitcoin asset allocation, citing that bitcoin “offers a counterbalance to a series of growing risks that are associated with traditional investment practices.”

“We think a well-rounded portfolio includes investments in a basket of blockchain technologies (altcoins), with an emphasis on Bitcoin. This portfolio can play a part in three distinct strategies: as an insurance policy, as a hedge in a broad speculative portfolio, and as a calculated bet on an early retirement.”

• Tuur Demeester

According to Demeester, even the most conservative investment portfolios should contain 1-2 percent in cryptocurrencies, particularly bitcoin. A speculative portfolio should include 2-5 percent, while an aggressive portfolio for an investor looking for early retirement should hold 5-10 percent. Investing in bitcoin, like other investments, is not without risk. “We believe returns of 100x over 10 years are possible, though obviously not guaranteed,” Demeester wrote.

While the price of bitcoin is impossible to predict accurately, Daniel Masters estimated in December that “the price of bitcoin could test its 2013 highs of above $1,100 next year and then pick up speed to rise to $4,400 by the end of 2017.” Masters co-founded Global Advisors, a multi-million dollar bitcoin hedge fund based on the island of Jersey. Masters started his career trading oil for Shell in the mid-1980s and spent 3 decades in commodities before he discovered Bitcoin.

Record highs have also been predicted for bitcoin in 2016 as the mining reward halves in June, permanently reducing the supply of new bitcoins by 50%. Bobby Lee expects this event to have a significant effect. Lee is CEO of one of the leading bitcoin exchanges in China, BTCC, and said that the price could increase by as much as eight times between now and the coming reward halving, shooting the price up as high as $3,500 before this summer. "For such an innovative, decentralized digital asset, I say ‘boy, are we undervaluing it’. But it takes a while for people to realize that."