Asset Allocation With BitCoin

Bitcoin… you either love it or hate it. You hate it because it keeps going higher. And you don’t know why. You love it also because it keeps going higher. And you either think you know why or you don’t really give a damn why.

It Is A Crazy World Today

Crazy? Well, we are in crazy times. Bitcoin is not the only monster. There is Tesla (TSLA) which defied all odds rising to trade at a mind-blowing PE ratio of more than 1600 at one point. Then more recently, there is GameStop Corp (GME). A story of common folks banding up to take on the institutional Goliaths. They won. Their efforts sent the stock flying from 17 bucks at the start of the year to well over $400 in less than a month. Many attributes that to the power of social media, technology, cheap access to the financial markets, and an increasing wealth divide fueling resentment against the rich and powerful.

You can’t blame such behaviors. When US Fed bailed out the rich time and again with their money printing, they prevented wealth from redistributing. With that much money in the system today, it is not hard to see where the bulk of it went. It is definitely not to the average man to put food on the table. Much ends up in the markets. And if you want a share of that, you got to be in it.

Can We Fit Bitcoin Somewhere?

Now before I proceed, let me put in some disclaimers. First, I am not an expert in bitcoin or any other cryptos. And neither am I personally invested. I am a quantitative investing practitioner. So for me, this is purely an analytical exercise to see how bitcoin affects the performance of a traditional portfolio.

Risk Parity Portfolio With BitCoin

  1. An All-Weather Strategy
  2. Common Sense In Diversification
  3. Your Asset Selection Matters
  4. Is It Game Over

If you are interested, I also teach a series of investing courses. And one of those focuses on Risk Parity. It is called All-Weather Investing Via Quantitative Modelling In Excel. It covers everything from its concepts to model development and deployment.

1 — The SPY/IEF/BTC Risk Parity Portfolio

Backtest Results Oct 2014 — Feb 2021

I must say the results looked really promising. Well, I do expect the returns to be better. Bitcoin has a spectacular run. So when you add it to any portfolio, this is pretty much a given. What is however worth mentioning is it almost doubles the CAGR from 5.6% to 10.1% with only a minimal increase in risk. That results in a markedly higher Sharpe Ratio of 1.85. And despite Bitcoin being dramatically more volatile and having an immensely turbulent period in 2018, the maximum drawdown experienced is only -4.4%. All these are achieved with an allocation ranging from 1% to 14% to bitcoins each month with the average allocation hovering around a modest 5%.

2 — The SPY/TLT/BTC Risk Parity Portfolio

Backtest Results Oct 2014 — Feb 2021

Again, the results are pretty impressive. The CAGR increases to 16.2% beating even SPY’s 13.5% which is high by historical standards. Volatility remains low at 10% with a drawdown around half that of SPY. If we look at the Sharpe, the risk parity portfolio with bitcoin outdoes all the rest once again. The higher return and volatility are the result of using a more volatile bond ETF and an increased allocation to BTC. The monthly allocations to BTC ranged from 3% to 16% with an average of around 8%. While this is higher than our previous portfolio, it wasn’t drastically different.

3 — The SPY/TLT/GLD/BTC Risk Parity Portfolio

Backtest Results Oct 2014 — Feb 2021

The results also improved by a good amount. This is both in terms of absolute returns and risk-adjusted returns. CAGR rose to 14.1% which is higher than both SPY as well as the risk parity portfolio without BTC. Both volatility and drawdown are also still much lower compared to SPY. The monthly allocations to BTC range from 1% to 17% with an average of around 6%.

Ending Note — Bear These In Mind

1. The history is short

2. Bitcoin and stocks both head south together

Let’s look specifically at how the different assets perform during months or periods where SPY pullbacks or drop more than 2%.

From the chart, Bitcoin’s behavior seems to run counter to what people expect. Because the results suggest that SPY and Bitcoin go down together more often than not in critical times. This includes periods such as Volmageddon from Feb 2018 to Mar 2018), the big stock market selloff in the last quarter of 2018, and the recent pandemic crisis from Feb 2020 to Mar 2020. So I wouldn’t depend on bitcoin to save my ass if the stock market enters a serious correction or bear market. To weather different conditions, you will still need other assets in your portfolio.

3. Where is Bitcoin headed?

Personally, I don’t think bitcoin will become something that entirely replaces fiat currency. If it does, its value won’t be wildly swinging around like what it did and it would lose its appeal. It would also be inconceivable for central banks to sit around and let it come to the extent that it replaces the dollar without any intervention. Because the central bankers would then have to pack their bags and go home. One of their core jobs is to monitor and control the money supply. And when that happens, they can’t do either.

Bitcoin has grown significantly enough to warrant a place as a key asset in the market. But it is still small when it comes to mainstream usage. And of course, its acceptance hinges on the fact that it can be readily converted into the dollar. So the chances of an outright ban on it are slim as many market participants are involved now. And it may be some time away before we see it being put to any test. As to how the scenario will play out when that happens, I have no idea.

See you in my next post.

Originally published at on February 19, 2021.

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