The Benefits of Investing in Bitcoin in a Modern Portfolio

Updated: May 19

Should I invest in Bitcoin? We often get this question across social media, through client inquiries and general conversation.


The short answer is YES. Even if you hate it or don't understand it, the data shows that at least a 1% position is warranted for diversification purposes and enhancing absolute and risk-adjusted returns.


Bitcoin was the best performing asset over the past decade yet very few individuals have any exposure to it at all. At DAiM (Digital Asset Investment Management), we believe in Bitcoin’s emerging potential as a non-sovereign, hard capped fixed supply decentralized form of digital money and the ability for Digital Assets as a whole to improve the efficiency and accessibility of our global financial system.


We strongly advocate that every single individual should have at least 1% and up to 6% exposure to Bitcoin in their overall portfolio. Whether you believe in Bitcoin as a new form of money, as a hedge to unlimited printing of fiat currency, you like “blockchain technology” and its ability to create business models that democratize information and value in incredible new ways or you just want to have a little diversification in your 401k and make some extra money, the data is showing that having ZERO exposure to Bitcoin is not only irresponsible but becoming a financial risk.


Modern Portfolio Theory


Let us first start off by pointing out how rare it is that an entirely new asset class is born. Yet, through a combination of cryptography, monetary theory, game theory, economics, and network theory, Bitcoin has emerged and developed an entire asset class of Digital Assets unlike any other. As Bitcoin and Digital Assets transform our global financial infrastructure and challenge Modern Monetary Theory (governments and central banks have a monopoly on printing unlimited amounts of money and making you poorer in the process), we believe Bitcoin offers one of the most exciting investment opportunities of the 21st century.


Consistent with Modern Portfolio Theory, we generally subscribe to the notion that the optimal return-to-risk ratio for a portfolio can be found on the efficient frontier. New asset classes are powerful because they offer a unique return stream that can provide a diversification benefit. Whether you have a positive, negative or undecided opinion of Bitcoin because you don’t understand it, we will model out out how Bitcoin, as a brand-new asset class can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns.


Let's look at the data of Bitcoin in a Multi-Asset Model Portfolio


Recently, a large wealth manager publicly shared the exact allocation of their Model portfolio(I removed their name bc I’m going to be trying to work with them as partners long term). It’s easy to run standardized 60/40 Equity/Bond Portfolios but given the detailed breakdown of holdings and asset allocations, I was excited to see what the data would show.


For the purpose of this exercise I am going to run their current “Model Portfolio” as is and then with a 1%, 3%, 5%, 7.5% and 10% allocation to Bitcoin over the most recent 5year period from April 2015 until April 2020.



Example #1: BFW Customized Model Portfolio (April 2015 - April 2020)

Portfolio Allocation


Data Notes:

  • IWM was used in place Aristotle Small Cap Equity (ARSBX) due to lack of historical data

  • VanEck Vectors BDC Income ETF (BIZD) was used in place of “Private Credit”

  • S&P500 ETF Trust (SPY) was used in place of Parametric S&P500 due to lack of available data


Additional Backtesting: S&P 500 & Bitcoin (April 2015 - April 2020)


Example #2: Popular Mutual Fund Multi-Asset Portfolios:

Blackrock Multi-Asset Income and Vanguard Managed Payout (April 2015 - April 2020)



Correlation


Despite its volatility, Bitcoin did not exhibit any significant correlation with other asset classes over the same period, with a median correlation coefficient with other asset classes below 0.20. Irrespective of the study period, Bitcoin remains uncorrelated with all other non-crypto financial instruments and asset classes. As illustrated in the two charts above, Bitcoin (as an asset class) has the lowest correlation closest to other asset classes.


Key Findings:


Looking at the results above, it appears that portfolios containing an allocation to Bitcoin performed even better than the standard BFW Model Portfolio, on both an absolute and risk-adjusted basis. For example:


  • a 1% allocation to Bitcoin to the BFW Portfolio increased annual returns by 271 bps. That's a 62% improvement in annual returns and over 18% increase in absolute return over the 5yr period for an additional 36bps of risk.

  • a 1% allocation to Bitcoin improves the Sharpe and Sortino Ratios by 62% and 69% respectively demonstrating a improvement on both an absolute and risk-adjusted return basis

  • adding a 3% allocation to Bitcoin to the BFW Portfolio increased annual returns by 778 bps, while improving the BFW Sharpe and Sortino Ratios by 146% and 198% respectively

  • during BFW’s worst year, the portfolio WITHOUT any allocation to Bitcoin was the worst performer. This includes the 75% Bitcoin drawdown in 2018. The max drawdown is virtually the same between the portfolio w/ 1% allocation to Bitcoin then the portfolio without

  • every incremental allocation to Bitcoin up to 10% produces a significant increase in both your sharpe and sortino ratios as well as absolute returns, offering more optimal portfolios along the efficient frontier

  • a 3% allocation to Bitcoin would offer a higher return and considerably lower standard deviation then the S&P average over the same time period

  • When looking at BlackRock and Vanguard multi-asset portfolios, a 3% allocation to Bitcoin over the same 5yr period would offer a considerably lower standard deviation of 10.1% & 11.48% vs the S&P average of 14.52% while offering returns of 10.9% & 10.5% vs 9.09% over the same time period

  • The most inefficient portfolios are all portfolios with ZERO allocation to Bitcoin


Given our understanding of portfolio theory, this is not all surprising. Since Bitcoin is uncorrelated with traditional assets over a multi-year basis, combining it with traditional multi-asset portfolios can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns. While it goes without saying that an allocation of over 5% to an incredibly risky new asset class like Bitcoin is far too large in a multi-asset portfolio even though you are compensated for the excess risk, it is our strong belief that having zero exposure to Bitcoin at this point is the wrong allocation as well.


We are making the case for allocating 1% to Bitcoin using DAiM


At Digital Asset Investment Management (DAiM), we believe in Bitcoin's potential to capture a share of some of the largest markets in the world (e.g.,Money, Store-of-Value). We believe its underlying technology can improve the efficiency and accessibility of our global financial system while creating a way for humans to transact and transfer assets and data without the need for third party intermediaries. This is why we’ve built the first Registered Investment Advisor properly licensed to manage and advise for Bitcoin and Digital Assets.


While it’s still early in the adoption process for Bitcoin and Digital Assets, there is a compelling case for investors to allocate a small portion of their portfolio to Bitcoin for diversification purposes and to achieve higher risk-adjusted returns.


As a licensed and regulator vetted Investment Manager, DAiM can offer the ability for Individuals and Wealth Managers to invest and allocate to Bitcoin directly in a regulated way.


For individuals, we offer access to invest in Bitcoin directly through separately managed accounts:


  • Cash Brokerage accounts

  • Qualified Retirement Accounts

  • 401ks, IRA’s, Roths, SEPs

  • Self-directed retirement accounts


For Wealth Managers we offer access to Bitcoin through DAiM as:


  • Sub-advisors and SMA’s

  • Third Party Asset Manager for funds and investment vehicles


For more information on both the fundamental and investment thesis for Bitcoin, please see “Get Off Zero: The Case for Bitcoin and Why a 1-6% Portfolio Allocation Should Be Considered”


Advantages for Wealth Managers to use DAiM to offer Bitcoin to Clients:


Investor interest in Bitcoin continues to grow while access to Bitcoin through Investment Advisors is largely unavailable. Currently, if an investor wants exposure to Bitcoin, they have to pull investable assets from their fiduciaries and send funds to risky exchanges and self-direct options. These options are harmful to investors, exploiting them by charging punitive setup and transaction fees, encouraging trading and promotion of high-risk alternative digital assets. If investors want exposure to Bitcoin, we believe they would be best served by working with an Investment Advisor like DAiM.


Why use DAiM to offer my clients exposure to Bitcoin and Digital Asset Investments?


Because we are…

  • Properly licensed, and operational process and partners have been vetted by regulators

  • Only working with other licensed counterparties. This ensures proper compliance and accountability

  • Developed a secure way to custody Bitcoin while never taking custody of client assets

  • Not a hedge fund. We charge a flat fee to manage and advise, no performance and do not add any hidden fees or expenses.

  • Able to help you differentiate from other Investment Advisors and diversify client portfolios, while building portfolios with higher risk-adjusted returns

  • Keeping assets in house that otherwise might leave for digital exchanges, you can continue to earn AUM fees and understand your client's full financial picture


For more information please contact Adam Pokornicky at 949.298.7582 or adam@daim.io

© 2020 by Digital Asset Investment Management

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Newport Beach, CA 94158