The impact of adding digital assets to a traditional portfolio
Digital assets – a new investment frontier
Digital assets, and protocol tokens, present a new investment frontier. They are an emerging industry and asset class which offer the potential for significant upside. At the end of 2015, the price of Bitcoin was USD 423, and at the end of June this year it was USD 9,188, an increase in value of about 22x over the past four and a half years. However, as with every new frontier, risk and market dynamics come into play.
In this article, we quantify the potential impact on risk and return when adding a small allocation of digital assets to a traditional portfolio using historical data. To do this, we simulate the performance of three potential portfolios:
A traditional portfolio with 75 percent equities and 25 percent fixed income
A traditional portfolio incorporating 5 percent allocation to Bitcoin
A traditional portfolio incorporating 5 percent allocation to Ethereum
Adding Bitcoin and Ethereum to a traditional portfolio can boost returns
By tracking the performance of the three portfolios from end of 2015 to end of June 2020, we see that the portfolios with a 5 percent allocation to Bitcoin or Ethereum significantly outperform a portfolio with no allocation to digital assets (figure 1). A traditional portfolio would have increased in value by 39 percent, while one with a 5 percent allocation to Bitcoin or Ethereum would have increased by 71 percent and 139 percent, respectively. In addition, we see a stronger recovery in the portfolios with digital assets after the market crash in end March.
Volatility increases when adding Bitcoin or Ethereum, but portfolios still outperform on a risk-adjusted basis
On the risk side, daily volatility increased from 12.0 percent to 12.6 percent and 14.2 percent with the addition of Bitcoin and Ethereum respectively for the same period. However, the outperformance when digital assets are included is still significant after adjusting for increased risk –the Sharpe ratio for the portfolio without digital assets is 0.63, while it is 1.01 and 1.50 for the portfolios with Bitcoin and Ethereum (figure 2). We see the same outcome when we look at another measure of risk, the maximum 1-year drawdown and its corresponding Calmar ratio.
Low correlation to other traditional asset classes
To add to the benefits of investing in digital assets, historical data over multiple years shows that the performance of Bitcoin has a low correlation to that of traditional assets such as equity, fixed income, hedge funds and gold (figure 3). For the most part, correlation hovers between 0 percent to +/- 10 percent across asset classes, although there are unique circumstances where this may increase. Since the market crash in March this year, where all assets fell in tandem during a sharp risk off driven by the global outbreak of COVID-19, correlation has increased and currently ranges between 20 to 30 percent. However, this is still considered fairly low and given the unprecedented situation that we find ourselves in globally, it is hard to draw any definite conclusion on the behavior of assets at this point.
Digital assets can be incorporated as part of a smaller satellite portfolio to diversify and boost returns
Looking at historical numbers, the case for digital assets is compelling.
While highly volatile as an independent asset class, in the context of a portfolio a small allocation to digital assets increases risk slightly, while increasing performance significantly.
Ethereum, being a more nascent protocol, is a riskier asset than Bitcoin, but the volatility of the portfolio with Ethereum still remained well below 20 percent. Investors can optimise their allocations according to their risk appetite. In addition, with a low correlation to other asset classes, digital assets are an ideal diversifier to a traditional portfolio.
 Publicly available sources of market data
This document was prepared by Sygnum Bank AG. This document may contain forward looking statements and may be subject to change. The opinions expressed herein are those of Sygnum Bank AG, its affiliates and partners at the time of writing. The document is for informational purposes only and contains general material. It is for use by the recipient only. It does not constitute any advice or recommendation, an offer or invitation by or on behalf of Sygnum Bank AG to purchase or sell assets or securities. It is not intended to be used as a general guide to investing, and should be used for informational purposes only. When making an investment decision, you should either conduct your own research and analysis or seek advice from an expert to make a calculated decision. The information and analyses contained in this document have been compiled from sources believed to be reliable. However, Sygnum Bank AG makes no representation as to its reliability or completeness and disclaims all liability for losses arising from the use of this information.