Bitcoin’s Appeal May Be Growing For Traditional FundsBy Nick Chong
For the most part, investors abiding by traditional investment strategies have avoided Bitcoin like the plague. Legendary investor Warren Buffett, for instance, once called the cryptocurrency "rat poison squared", later explaining that there isn't much inherent value in the project. Other notable players in finance and politics, including U.S. President Donald Trump, have echoed this analysis, using phrases like "thin air" and "unbacked" to get their point across.
Unlike traditional stocks and assets, Bitcoin doesn't provide a fixed yield, a dividend, or generate cash flow. And compared to traditional and modern fiat currencies, BTC isn't backed by the power of a government or the scarcity of an underlying asset. The foreign elements of the cryptocurrency have thus led most traditional investors to cast it aside.
However, some people believe that adding Bitcoin to a traditionally-weighted portfolio with a fair mix of low-risk bonds and growth stocks could provide investment funds with appealing returns and an increasingly acceptable level of risk.
A Great Diversifier
Crypto enthusiasts have argued that Bitcoin makes sense for traditional investors. For example, in a recent report titled "Diversification Benefits with Bitcoin", the "institutional-grade" research arm of crypto unicorn Binance claimed that including Bitcoin in traditional multi-asset class portfolios provides overall better risk-return profile.
Binance acknowledges that Bitcoin is subject to massive drawdowns and ghastly bouts of volatility, but argues that this is balanced by its remarkable returns during bull runs. Additionally, Bitcoin hasn't shown a clear, consistent, and significant correlation with traditional asset classes like American stocks, emerging markets, commodities, or debt. As the firm's research team wrote:
"All simulated portfolios which included Bitcoin exhibited overall better risk-return profiles. [...] These results show that Bitcoin provides active diversification benefits for all investors worldwide, following multi-asset strategies.”
Delphi Digital, a New York-based cryptocurrency market research outfit, published a similar argument in December of 2018, in the midst of Bitcoin's 85% sell-off from the $20,000 peak. In its seminal "State of the Network" report, the firm wrote that “using a simple tiered-allocation analysis,” a portfolio that is made up of 57% stocks, 40% bonds, and 3% Bitcoin yielded the highest Sharpe Ratio (a popular measure of a portfolio's risk-return potential) and sported the smallest max drawdown in simulated scenarios. Compared to a 60% stock and 40% fixed-income (bond) portfolio, the portfolio with hints of Bitcoin draws down 1.5% less than its traditional counterpart.
The team's researchers did admit that Bitcoin's outperformance may not continue, but explain that their thesis will allow for "traditional portfolios [to benefit] from a small allocation to Bitcoin over the coming decade, especially as the expected returns for other risky asset classes appear lackluster.”
Bitcoin statistician “PlanB” also made a similar point in January, prior to Bitcoin's recent price explosion, saying that a theoretical portfolio with a 99% cash allocation and a 1% Bitcoin position with a certain investment formula has outpaced the S&P 500 over the past 10 years. In other words, one of the most powerful stock market runs in human history has been outpaced by one of the safest portfolios to exist — one with a maximum potential loss of 1%.
Bitcoin's ability to bolster returns is not unproven. According to a recent report from Bloomberg, Bill Miller, a prominent hedge fund manager, recently leveraged the cryptocurrency to boost the performance of his $2 billion fund. Bloomberg claims that year-to-date (as of July 31st), Miller Value Partners has gained 46% by having capital allocated towards Bitcoin and Amazon — both of which have appreciated dramatically since the start of 2019.
Since the start of the year, the S&P 500 has gained 7%, gold has appreciated by some 16%, and shares of Warren Buffett's Berkshire Hathaway have actually lost 2.5%. Bitcoin, on the other hand, has rallied by some 200%.
This dramatic outperformance hasn't gone unnoticed. In a report published back in June, Delphi Digital dubbed Bitcoin the "King of the Hill" of all asset classes, specifically due to its ability to outperform everything when a majority of assets are either falling or starting to lose their upward momentum. While the Delphi Digital chart below is from May 2019, it does show how Bitcoin is separating from the pack.
A July article from LongHash also pointed out that in Bitcoin’s 3,837 days of existence, the cryptocurrency has only been a bad investment on 60 of those days.
Funds are Underperforming
By contrast, hedge funds and pension funds are underperforming their benchmarks and targets. In early 2019, the Financial Times reported that hedge funds have seen their gains absolutely tank over recent years. From 1989 to 1999, as the Dotcom Bubble was inflating, the average hedge fund posted 18.3% per annum. The next decade, they returned just 6.4% a year. This decade, they’ve produced a mere 3.4% a year. While a yearly 3.4% gain is outpacing inflation as defined by the consumer price index, it isn't too amazing in the grand scheme of things.
Pensions aren't doing too much better. In December of 2018, back when Bitcoin was trading under $4,000 as investors declared the cryptocurrency "dead", industry venture investor and well-known Bitcoin booster Anthony Pompliano made it clear that there is a "pension crisis" brewing across the globe.
In an installment of his newsletter, Off The Chain, the former Facebook and Snapchat employee explained that the California Public Employees’ Retirement System, the largest public pension fund in America, with $300 billion of assets, is less than 70% funded. And this is far from the only pension fund taking heat. In Japan, the Government Pension Investment Fund lost 9.1% — $136 billion — in the fourth quarter of 2018 alone.
Should retirement funds continue to stick to the status quo, they may not be able to satisfy the needs of their beneficiaries. That’s an ever-growing demographic, particularly in aging nations like Japan.
According to Pompliano, Bitcoin may be the answer. Numerous analysts have demonstrated that, at least based on past performance, including the cryptocurrency makes sense from a risk management perspective, as it mitigates losses and improves potential returns.
Bitcoin as a Hedge in Trying Times
That's not the end of the story. Bitcoin can potentially improve returns, but it may have an additional function as a hedge against macroeconomic and geopolitical risk.
While Bitcoin was marketed by Satoshi Nakamoto as a form of digital cash, many economists and investors see it, especially in its current form, as a digital alternative to gold. Much like the precious metal, Bitcoin is scarce, decentralized, non-sovereign, hard to produce, fungible, and can be transported across the globe.
Chamath Palihapitiya, a former Facebook executive and current venture capitalist, recently told CNBC in July that he thinks that Bitcoin is the best hedge against the traditional fiat architecture, calling BTC "schmuck insurance" that you keep under your mattress.
Even analysts of banks and investors appearing on mainstream media outlets like CNBC, have begun to acknowledge this narrative, specifically due to Bitcoin's deflationary and decentralized nature. Deutsche Bank's Jim Red, the institution's head of thematic research and credit strategy, told CNBC in a June interview:
“If central banks are gonna be this aggressive, then alternative currencies do start to become a bit more attractive."
It's Happening Already
Bitcoin is already proving itself as a hedge and diversifier. China and the U.S. are currently duking it out, implementing tariffs and imposing interesting monetary policies. Hong Kong has been subject to months of unrest due to protests, resulting in a falling stock market. Foreign currencies are falling against the U.S. Dollar, with the Argentinian Peso shedding 15% on Monday. Global debt continues to set records, especially as nations continue to try and boost their economies through fiscal spending, and so on and so forth.
But during all this, Bitcoin has outperformed, rallying by 200% since the start of the year.
Crypto enthusiasts have long been sold on Bitcoin. But the case for traditional investors is looking a lot more solid.