Close Close
Sign In
Newsletters
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Podcast Center Video Center Webcasts Resource Center Events
About ThinkAdvisor Contact Us Advertise With Us Asset & Logo Licensing Sitemap Terms of Service Privacy Policy Copyright © 2024 ALM Global, LLC. All Rights Reserved.
ThinkAdvisor

Portfolio > Alternative Investments > Cryptocurrencies

4 Reasons to Rethink Adding Bitcoin to a 60/40 Portfolio

By Ginger Szala

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • A Morningstar study found that adding Bitcoin to a 60/40 portfolio adds risk and can add more volatility.
  • Clients will need nerves of steel to hold onto Bitcoin in times of increased volatility.
  • Advisors need to counsel clients on the downside of Bitcoin investments.

Cryptocurrencies have bred skepticism among advisors, but some are starting to come around. A Grayscale paper found that 10% of advisors were recommending crypto for portfolios, and a Financial Planning Association survey found even more optimism about the emerging asset class.

The 2021 FPA survey, released in June, found that 26% of advisors plan to increase their use or recommendations of cryptocurrencies in client portfolios over the next 12 months, up from less than 1% a year ago.

But those advisors would be wise to proceed with caution since, as Morningstar put it in the title of a recent article, even a Little Bitcoin Can Change Your 60/40 Portfolio a Lot, and not always in a good way.

Here are four findings from that article by Adam Millson, manager research analyst for Morningstar, in which he reviewed Bitcoin’s historical volatility and returns versus stock and bond portfolios.

Caveats of the study include that it is a “backward-looking exercise of a wildly volatile asset without a very long history,” Millson states. The research also ignored related costs of the cryptocurrency, “which can be significant,” he added.

1. Volatility Matters

Although the likes of Ark Invest CEO Cathie Wood can stomach the ups and downs of Bitcoin — which had as much as a 1,300% return in 2017 and 300% gain in 2020 — the drops are significant. The paper compares a rolling one-year standard deviation using returns over the life of the CMBI Bitcoin Index (launched in July 2010) to a 60/40 portfolio tracking the Morningstar Global Markets Index and Morningstar US Core Bond Index — rebalanced monthly.

Millson found that Bitcoin was not only 13 times more volatile over that period than a 60/40 portfolio, but also 8.6 times more volatile than a 60/40 portfolio over a one-year trailing period.

2. The Risk Factor

Millson points out that different asset classes in a portfolio contribute different amounts of risk. In a typical 60/40 portfolio, equities contribute about 90% of risk. “With that in mind, the impact on the risk profile of the same portfolio by introducing bitcoin, which is incredibly more volatile, is jarring,” he writes.

Case in point: Millson found that adding a 1% or 2% allocation to Bitcoin to a 60/40 portfolio contributed from 9% to 24% to total risk, while volatility was barely affected.

As expected, however, greater exposures to Bitcoin had more impact. An allocation as small as 5% contributed more than 60% of the portfolio’s risk and increased volatility by about 70%. The higher the allocation, the higher both risk and volatility.

3. Nerves of Steel

Will investors and their advisors hold onto crypto in volatile times despite returns? From mid-April through June 25, 2021, Bitcoin fell 50%, which “isn’t a new phenomenon” for the cryptocurrency, Millson states.

Those who could hold on at those times may have “reaped the benefits,” he adds. But is it worth it? He states that a balanced portfolio with a 5% allocation to Bitcoin over the past decade had just over a 15% return when sourced either from bonds or equities. That outpaced a 60/40 portfolio of 7.3%. During that 11-year period, however, the CMBI Bitcoin index had peak-to-valley drops ranging from -41% to -93%.

The non-Bitcoin 60/40 portfolio returned about 6.8% on average during these Bitcoin stress periods, Millson states. And during the pummeling of Bitcoin from April through July 25, the standard 60/40 portfolio gained 1.9% while the Bitcoin-infused portfolio “trailed that mark by three percentage points. It can be difficult to stick with portfolios that are struggling when stocks and bonds are doing well,” he states.

4. Correlation Rising?

One plus of adding Bitcoin to a portfolio has been its lack of correlation to stocks and bonds. However, Millson found that recently, Bitcoin’s rolling correlation to the broader equity markets hovers between 0.25 and 0.35. “Yes, that’s still low and it may fall back to near zero again, but it’s still notable,” he says.

That said, if there is a “sustained shift” of correlation, “the importance of where the allocation is sourced increases.”

He concludes that those investors — or advisors — considering adding Bitcoin to a portfolio must keep in mind the product’s volatility, noting that “although past performance may look particularly strong, it is no indication of future results.”

Ginger Szala

@gingerszalaink

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.