Does Crypto Allocation Enhance Your Portfolio?

Cryptocurrencies have seen a sharp rise in interest since the Reserve Bank of India (RBI) lifted the ban in March 2020, with Indian exchanges seeing impressive user additions and a steady increase in daily trading volumes. For example, WazirX saw record trading volume of over $43 billion in 2021 – the highest in India – accounting for a growth of 1,735% over 2020.

Crypto is a new breed of asset class which has given high returns but with equally high risk. They are growing in adoption around the world and some experts believe they are worthy to be included in an investment portfolio.

“It’s like Warren Buffett says, “Don’t put all your eggs in one basket. You need all the different types of asset classes in your portfolio; As well as certain commodities, crude oil, currency, stocks, bonds and crypto. If you want to maintain a balanced portfolio, you need to have them all,” said Siddhartha Sogni, founder and CEO of Crabco Global, a research firm focused on blockchain and cryptocurrencies. Sogni suggests that A 4-5% allocation in crypto assets can limit downside risk and boost the overall portfolio.

But how much does crypto boost the portfolio? We compared a standard investment portfolio of equity and debt in the ratio of 60:40 to a portfolio containing equity, debt and bitcoin in the ratio of 55:35:10 over the past five years.

The data showed that 1,00,000 invested in a standard format at the beginning of the calendar year 2021 ( 60,000 equity and 40,000 debt) would have attracted investors 1,13,600. However, adding 10% to the portfolio mix will increase the year-end returns 1,18,725. Furthermore, backtesting of this model revealed that in 2017, a standard portfolio of 1,00,000 increased. Would have been done 1,17,600, while bitcoin could bring the portfolio 2,54,800. However, it hasn’t been smooth sailing for crypto assets, as bitcoin fell over 70% during 2018, which could have propelled a crypto portfolio (equity 55%, debt 35% and bitcoin 10%) into the negative. . Financial advisors have a word of caution here. According to him, those who are in the process of setting up their overall investment portfolio should not venture into crypto assets.

“We suggest people to take care of their core portfolio first, and on top of that, if they have some investable surplus after taking care of all their financial objectives, they can try to diversify, perhaps, 2-3% of the portfolio. In crypto, if customers insist. However, investors should consider that it is a high risk, high return investment.”

A core portfolio is the mainstay of an investor’s portfolio in that they generally do not take on much risk. While crypto assets, bitcoin in particular, are seen as a new asset class that offers some diversification from traditional asset classes, questions have been raised in recent days.

According to a recent report by the IMF, before the pandemic, crypto assets such as bitcoin and ether showed little correlation with major stock indices. “They were thought to help diversify risk and act as a hedge against swings in other asset classes. But this changed after extraordinary central bank crisis responses in early 2020. Stocks rose amid both easing global financial conditions and greater investor risk appetite,” wrote IMF’s monetary policy and capital markets experts.

For example, according to the IMF, returns on bitcoin did not move in the same direction as the S&P 500, the benchmark stock index for the US, during 2017-19. The correlation coefficient of their daily moves was just 0.01, but the measure jumped to 0.36 for 2020-21 as assets moved higher in lockstep, rising together or falling together.

Strong correlations suggest that bitcoin is acting as a risky asset. Its correlation with stocks has become greater than that between stocks and other assets such as gold, investment-grade bonds and major currencies, pointing to limited risk diversification benefits.

The strong relationship between crypto and equities is also evident in emerging market economies, many of which have led the way in crypto-asset adoption. For example, according to the IMF, the correlation between the MSCI Emerging Markets Index and the return on bitcoin in 2020-21 was 0.34, which is 17 times higher than in previous years.

However, Sogni opposed this, saying that geopolitical conditions do not fundamentally affect the price of bitcoin. “Of course, whenever there is a panic like the covid pandemic or a global market crash, there is some price impact, but this is a different segment that recovers faster than traditional assets,” he said.

According to the expert, bitcoin price may trade sideways in the first quarter. “As of April, I am looking at like $50,000-$55,000 range and once we break the upper side and everything is done according to technical analysis, we can still see $85-90,000 this year But it depends on when bitcoin will gain momentum,” Sogny said.

While investors may be increasingly attracted by the meteorological returns offered by some digital assets, financial advisors have a word of caution.

“I still believe that crypto assets should not be added to the portfolio. It is only for those investors who already have their finances and investments sorted out and who have some surplus surplus on which they can invest some money. Can place additional bets,” Chetanwala said.