Just the right amount of Bitcoin

By   James Butterfill 24th September 2020

In our last piece we established that bitcoin enhances risk adjusted returns in a traditional 60/40 equity/bond portfolio. Here we ask, ‘Historically, what’s the right amount of bitcoin?’

Our research indicates that:

  • Small weightings of bitcoin have had an outsized positive impact on both risk-adjusted returns and diversification relative to other alternative assets.
  • Increasing risk (annualised volatility of the portfolio) by 1.2% suggests a portfolio weight of just under 4% in a traditional 60/40 equity/bond portfolio.
  • Quarterly rebalancing of Bitcoin back to the original invested weight helps contain volatility.

Bitcoin has been a volatile asset since its inception in 2009, keeping some investors wary of investing. We believe, with relatively limited risk, an allocation to Bitcoin can be made that has a meaningful impact on portfolio performance.

In this article, we highlighted the potential diversification benefits that an allocation to bitcoin can provide to a traditional 60/40 equity/bond portfolio. In particular, Bitcoin’s lack of correlation to other assets potentially makes it a far more useful alternative asset for investors looking to reduce exposure to economic cycles, especially when compared to other popular alternative investments, such as gold or a broad basket of commodities.

So, how much should you invest in bitcoin?

Whilst there is no one-size-fits-all approach, we believe that Bitcoin is steadily evolving into a store of value, and a backtest of bitcoin price performance in a portfolio can still deliver valuable insights for long-term investors. We also believe that informing investors on the best Bitcoin portfolio allocation in their portfolio, according to their risk appetite, is essential.

To help investors understand how bitcoin can help or hinder a portfolio we created a database of daily returns starting from 2015 when the investors were first able to invest in the asset via an Exchange Traded Product (ETP). We started with a traditional balanced portfolio with 60% equities and 40% bonds and then added a notional amount of bitcoin, detracting from both equities and bonds equally.

As bitcoin is an asset in an early growth phase, most investors would allow its portfolio weight to drift to some extent. We decided to rebalance on a quarterly basis––despite its potential hindrance on enhancing returns––because we believe rebalancing helps moderate volatility. You can read more about the composition of this portfolio in this report.

Bitcoin Portfolio Allocation: Volatility

Adding Bitcoin to a portfolio does increase portfolio volatility. So how much should be added to a portfolio? There are several ways to approach this. One method is volatility targeting, and the chart below highlights how much Bitcoin in a portfolio contributes to risk.

As a guide, the chart highlights a 4% weighting in a portfolio would increase the overall portfolio volatility by just over 1%.

Bitcoin Portfolio Allocation: Sharpe Impact

An alternative approach is to blend the risk and reward by analysing the impact on the portfolio Sharpe ratio (a measure of returns relative to the level of risk taken on) in varying Bitcoin portfolio weights.