Does Bitcoin fit in a ‘normal’ portfolio?

Bitcoin’s spectacular rallies and crashes have investors scratching their heads about whether it fits in a balanced portfolio.

An admittedly brief history shows that a 60/40 allocation to stocks and bonds could be improved by some exposure to the digital asset, despite the risks. So what happens when investors take the plunge?

Tweaking a global portfolio of stocks and bonds to also include the digital currency at the start of 2015 would have seen annualised monthly returns increase, with bigger gains the more money is allocated to crypto.

That’s not a big surprise, since Bitcoin rose more than stocks or bonds. But just a 5% allocation would have produced gains to the investor 1.7 times bigger than using the standard mix.

The catch is that this also introduces Bitcoin’s 30-day annualised volatility of 81%. With just a 5% allocation and despite a low correlation with other assets, the volatility in the overall portfolio rose by 1.7 percentage points, based on a monthlyrebalancing rule. That’s a big price to pay in a market obsessed with the tradeoff between the size and predictability of gains.

The ultimate test, then, is the impact on risk-adjusted returns. And here’s the biggest surprise. In all allocations considered, Bitcoin improved the results.

Using the Sharpe ratio — a recognised measure of the tradeoff between volatility and gains — showed an improvement for all levels of crypto exposure considered. Adding just a 1% allocation of Bitcoin increased the measure from 0.69 to 0.79.

Those brave enough to move a twentieth of their portfolio to the digital asset would have seen a jump to 1.1. Earlier this year, analysis by JPMorgan Chase suggested exposure to Bitcoin could achieve an efficiency gain in risk-adjusted portfolio returns.

This is obviously a surface-level, backward-looking exercise of a highly volatile asset with a short track record and little obvious utility. It ignores the difficulties encountered when buying crypto in the early years, as well as its proclivity to trade at the mercy of mainstream influencers.

In short, understanding crypto’s use in a portfolio setting remains a hot debate, but perhaps it’s less scary if managed effectively.

Michael Read is a macro strategist for Bloomberg’s Markets Live blog. The observations are his own and are not intended as investment advice.