News of PayPal’s support for digital asset transactions and Singapore’s DBS Bank’s preparations for a digital asset transaction platform came out in the same month. The interest of mainstream financial institutions in Bitcoin is clear. In an environment where stock valuations of listed companies are high, bond yields are low, and wealth is shifting to millennials, people’s interest in alternative investment solutions is increasing day by day.
In late October, the Fidelity Digital Assets Division of the traditional asset management giant Fidelity Group released the ” Bitcoin Investment Theory: The Role of Bitcoin as an Alternative Investment ” report, which summarized the reasons for funding Bitcoin in detail and pointed out the advantages of Bitcoin Native digital assets will not be affected by the economic impact of the new crown pneumonia epidemic. If Bitcoin only occupies 5% of the alternative investment market, the market size of Bitcoin will expand to US$670 billion.
The report has attracted a lot of attention in the traditional investment market. Linkwent selected and translated most of the content of the report for readers.
Written by: Ria Bhutoria, Research Director of Fidelity Digital Assets Translation: Perry Wang
Break down the reasons why traditional investors allocate Bitcoin
The reason why some Bitcoin holders allocate capital to Bitcoin is similar to the reason they allocate capital to alternative investments . In addition, as the Federal Reserve (and many other central banks) lower their benchmark interest rates to zero (or even below zero) this year, interest in Bitcoin and other non-yielding alternative investments may also increase. In a world where the global benchmark interest rate is close to, equal to or even lower than zero , the opportunity cost of not rationing Bitcoin is higher .
Most people’s allocation of bonds is too high. All funds cannot be invested in the stock market. People’s initial starting point is to beat inflation. Some of the funds flowing out of bonds were absorbed by Bitcoin, which is a natural result.
Cathie Wood, the helm of ARK Invest, is known as the “female Buffett”
Portfolio diversification
Despite the relatively short time Bitcoin was correlated with traditional asset performance, but there are few such assets can be like Bitcoin, can longer period of time (eg, months or years) within the traditional Assets remain irrelevant . Therefore, investors who wish to re-adjust their investment portfolios should evaluate the effectiveness and impact of the allocation of funds to Bitcoin to determine whether Bitcoin can play a certain role in a multi-asset investment portfolio.
I think Bitcoin is my safest asset. It is a store of value with very low or zero negative profit.
Elisabeth Préfontaine, founder of Octonomics, a financial technology research, consulting and advisory organization
From January 2015 to September 2020, the positive correlation between Bitcoin and other assets (shown in the table below) averaged 0.11, which indicates that there is almost no correlation between Bitcoin’s earnings and other assets. The value of the “correlation index” we are talking about is in the range of -1 to 1. Correlation 1 means a complete positive correlation, which means that the two variables move together completely. A correlation of -1 means a complete negative correlation, and the two variables move in opposite directions. A value of zero (no correlation at all) or a value close to zero means that there is no correlation between the variables.
The low correlation is an encouraging signal for evaluating alternative investments through portfolio diversification tools. It is also important to explore why the correlation between Bitcoin and traditional assets is low and whether it will continue this trend :
- Different return and risk factors : The factors that explain Bitcoin ‘s returns are different from those that drive the returns of other asset classes.
- The value narrative is constantly evolving and changing : there are various narratives about what people expect Bitcoin to become and what to do in the future. Bitcoin’s changing narrative can explain why Bitcoin is not related to other assets.
- The degree of overlap between market participants has grown : Bitcoin is a young asset that has only recently been unlocked by traditional markets. Bitcoin is slowly being integrated into institutional portfolios, so the connection with other assets may become closer.
- Retail-driven phenomenon : Bitcoin as an asset is unusual because it is favored by retail investors first, and then institutional investors become interested in it.
Different return and risk factors
Alternative investments can generate different returns from traditional assets and bring unusual risk exposures. A study conducted by Yale University economists Aleh Tsyvinski and Yukun Liu examined whether the returns of digital assets (especially Bitcoin BTC, Ethereum ETH, and Ripple XRP ) are comparable to other asset classes (stocks, traditional currencies, and precious metal commodities) The returns are similar. According to their research and analysis, the return behavior of all digital assets (including Bitcoin) cannot be explained by the risk factors that explain the return of stocks, currencies or precious metals, nor can it be explained by non-persistent consumption growth, persistent consumption growth, and industrial production. This is explained by macroeconomic factors such as growth and personal income growth.
Instead, the two economists found that Bitcoin’s performance is driven by “ crypto-currency-specific factors, ” such as momentum (inertia) effects, and average and negative proxy variables for investor attention.
The momentum effect refers to a tendency that if an asset rises, its value may continue to grow. This is consistent with the view that Bitcoin is reflexive , and its price and emotions are self-reinforcing. The second factor that affects the price of Bitcoin is investor attention , which is measured by the number of tweets about “Bitcoin” in Twitter and the Google search data series (for example, if the number of Bitcoin mentions is unusually high, Then the asset value will increase).
Bitcoin 30-day price and sentiment rolling changes
It is worth noting that as digital assets mature, the factors that drive returns from digital assets such as Bitcoin may change. For example, historically, the performance of the Bitcoin blockchain has not been associated with changes in the basic indicators of Bitcoin prices . We believe that the ” fundamental ” in the context of digital assets refers to information, indicators and models that can provide insight into the health and growth of digital assets and networks. Those who pay close attention to digital assets know that due to the high level of speculative and emotional-driven trading activities, the performance of digital assets is not always determined by the “fundamental”. With the passage of time, along with the analysis of investors and market participants and the development of Bitcoin market participation behavior, its price performance may be more closely related to “fundamentals”, which is related to reflexivity and emotion. Will weaken.
The sentiment of global investors will definitely affect the price of Bitcoin, but Bitcoin has unique fundamentals that are not affected by the health and economic conditions caused by the COVID-19 epidemic (for example, Bitcoin’s cash flow or production Without any shrinkage).
Demand shocks (decreased consumer demand for goods and services due to home lockdowns and unemployment), supply shocks (restricted production or closure of supply chains), and subsequent policy responses by the government and central bank (quantitative easing and record low interest rates) ) Has a direct and fundamental negative impact on stocks and fixed income, commodities and legal tender. On the other hand, a decline in profitability or production, or an increase in the money supply will not directly affect the fundamentals and utility of Bitcoin. On the contrary, these unfavorable factors may increase the attractiveness of investing in Bitcoin , and investors are indeed paying close attention.
For me, Bitcoin is the only thing I have seen so far that has nothing to do with government decision-making processes and decision-making institutions, because in the final analysis, any other asset class, such as stocks, debt, real estate, and commodities, are all related to The legislative framework is closely linked, and the mutual binding and interaction in the financial market has caused many governments that act in this way to intervene together.
Chamath Palihapitiya, founder of venture capital firm Social Capital
The listed company MicroStrategy (MSTR) included Bitcoin as an investment target for the first time due to its unique risk/return characteristics. In August 2020, the company announced plans to use Bitcoin as an inventory reserve asset. In its second-quarter financial report, MicroStrategy detailed a new capital allocation strategy, including a plan to invest no more than $250 million in one or more alternative assets. These may include commodities such as stocks, bonds, gold, digital assets such as Bitcoin, or other asset types that have excessive free cash flow.
It is worth noting that MicroStrategy chose to invest the entire USD 250 million in Bitcoin in August 2020, buying a total of 21,454 Bitcoins, and in September 2020 an additional USD 175 million, investing 16,796 Bitcoins. There are a total of 38,250 bitcoins , which are worth about 425 million US dollars at current prices. The reasons for MicroStrategy’s move are the economic and public health crises, unprecedented economic stimulus measures, global political and economic uncertainty, and the risk of storing excessive free cash flow in the form of fiat currency or in the form of assets commonly used in corporate finance .
We believe that the combination of these factors and other factors is likely to have a significant depreciation effect on the long-term actual value of fiat currencies and many other conventional assets, including many types traditionally held as corporate assets. We found that Bitcoin’s global recognition, brand awareness, ecosystem vitality, network advantages, structural resilience, technical practicality and community spirit are convincing evidence, proving the advantages of Bitcoin as a long-term store of value asset class.
Michael Saylor, Founder and CEO of MicroStrategy
Evolving value narrative
Another perspective of the lack of correlation between Bitcoin and traditional assets is the lack of consensus value narratives . One of the reasons we started this series of research reports is to explore the dynamic narrative of Bitcoin. In any given time period, the value narrative of Bitcoin varies from means of payment, digital asset reserve currency, value store assets, or portfolio optimization tools. The lack of consensus on this issue may be an important reason why the transaction price of Bitcoin has not been consistent with other assets so far.
If there is still a lack of consensus on Bitcoin’s value narrative, then it may continue to be irrelevant to all other assets. On the other hand, if Bitcoin’s value narrative converges to a single argument, then its price trajectory with other assets of similar investment value may also be closer.
Jeff Dorman, chief investment officer of Arca, a digital asset management agency, clearly pointed out in his conversation with us that changes in the value narrative of related assets can determine their behavior trajectory and relevance.
Relevance is usually determined by the value narrative. It is usually based on people’s expectations . If Bitcoin’s value narrative starts to become more consistent, then Bitcoin’s relevance to certain asset classes may increase.
Jeff Dorman, Chief Investment Officer, Arca
The most striking value narrative this year is that Bitcoin is an emerging store of value assets . We discussed this theory in detail in a report “Bitcoin as an Aspirational Store of Value”. Recently, Bitcoin’s price trajectory has been unstable, with prices changing simultaneously with different asset classes every week. However, more and more market participants are optimizing its long-term potential to allocate capital to Bitcoin. Interestingly, due to concerns about real interest rates and inflation, the 60-day correlation between Bitcoin and gold reached a record high in early September.
60-day correlation between Bitcoin and gold and the S&P 500 Index
Although this is a noteworthy development, it remains to be discussed whether the Bitcoin/Gold correlation will remain in the long run. In the past, the correlation between Bitcoin and certain assets (including gold and stocks) has risen briefly , but this relationship will break over a longer period of time .
Increased overlap between market participants
In the early days of Bitcoin, the events and sentiments that affected the traditional market had little effect on the Bitcoin market. Bitcoin’s transaction infrastructure is completely independent of traditional market infrastructure. Bitcoin’s ability to react in real time to current events affecting traditional markets is very limited because Bitcoin transactions are not integrated into traditional market infrastructure.
As the infrastructure matures, participants in the Bitcoin market and traditional markets begin to overlap . Institutional investors can trade bitcoin futures and options on the same platform that trades other asset derivatives (such as CME Group, Bakkt). Retail investors can buy and sell Bitcoin on certain platforms that allow them to trade stocks (for example, Robinhood, Square Cash). As Bitcoin matures and the coverage of Bitcoin market participants expands, including more participants from traditional markets, the correlation (positive or negative) between Bitcoin and other assets may increase.
Retail drive phenomenon
As more institutions allocate capital to Bitcoin, this part of the investor community will definitely have a greater impact on the Bitcoin market. However, there is reason to believe that the influence of retail investors will continue.
Bitcoin was originally a retail asset and continues to receive the attention of many retail investors. A potential proxy parameter for measuring the interest of retail investors is the number of addresses holding less than 10 bitcoins (although there is no way to determine that they all belong to retail investors). As shown in the figure below, the number of addresses holding less than 10 bitcoins has been steadily increasing. In fact, when plotting the month-to-month changes, we can see that since January 2012, the month-end count changes for the number of addresses holding less than 10 bitcoins have only been negative 7 times.
The number of addresses holding less than 10 bitcoins
The number of addresses holding less than 10 bitcoins changes from month to month
The behavior of retail investors and institutional investors may be different, which may be another factor that causes Bitcoin to lack correlation with other assets, and those reference assets are mostly driven by institutional sentiment .
We can look at the evidence comparing the behavior of retail investors and institutional investors during the market diving in March 2020. Companies that primarily target retail investors, such as Coinbase, River Financial, and Sipex reported that when traders and institutional investors released a large number of bitcoin positions, the number of bitcoin bought by retail investors hit a record high . Coinbase stated that its retail trading department ushered in a substantial increase in cash and crypto deposits, new user registrations, and total transaction volume within 48 hours of the sell-off, compared to the average over the past 12 months. Coinbase also emphasized that most of the retail users active during this period were buyers.
However, the extent of the market downturn indicates that even if there are many retail investors holding coins, the level of Bitcoin held by non-retail holders is much higher. In the chart below, we demonstrate that the total number of bitcoins held in addresses with bitcoin holdings <1 is approximately 5% of the current supply (18.5 million coins). Although this number is low, the number of bitcoins in addresses <1 bitcoin has been rising .
Holding amount <1 Bitcoin The number of bitcoins owned by the address (calculated in native units)
We are also beginning to witness the era of retail recovery in the traditional market due to the rise of zero-fee transactions by major brokerages and the emergence of easy-to-use trading platforms- CoinShares Chief Strategy Officer Meltem Demirors emphasized this trend in our conversation . The channels that retail investors rely on to obtain financial information and advice are also turning to social platforms such as Twitter, Reddit, Telegram, YouTube, and Tik Tok. The information dissemination of these platforms is more viral and faster than traditional closed channels. . The acceptance of Bitcoin has been and will continue to be driven by the aforementioned platforms, explaining the connection between Bitcoin’s price performance and the aforementioned social media popularity. As a new wave of retail investors become familiar with these channels, some of their attention will undoubtedly flow to Bitcoin and other digital assets .
What makes Bitcoin unique is that it is driven by retail investors . Financial media and the way people consume investment information are changing, and influential people are more concerned than institutions. This is happening in the context of large-scale intergenerational wealth transfer . With the transfer of wealth and power from the older generation to the younger generation, Bitcoin is the first asset that has doubled its value by taking advantage of the change in the value narrative of our creation and consumption of investment.
Meltem Demirors, Chief Strategy Officer, CoinShares
Increase in revenue
The acceptance of Bitcoin in institutional portfolios today is comparable to the inclusion of emerging and frontier market stocks in portfolios in the late 1980s and early 1990s. The resistance to the inclusion of emerging market stocks at the time came from concerns about factors such as volatility and liquidity. However, over time, investors recognized the growth rates of these markets and the low correlation between stock markets in developing countries and stock markets in developed countries. As of 2018, emerging and frontier market stocks (approximately USD 5 trillion) accounted for approximately 11% of the global investable stock market (USD 43 trillion).
Emerging market stocks were considered not worth investing in at the time. There are such short-sighted people everywhere in the United States. A similar analogy can now be made. At the time, the allocation of 1% to emerging market stocks was considered an experiment. Bitcoin can be incorporated into this idea.
Cathie Wood, the helm of ARK Invest, is known as the “female Buffett”
The current market value of Bitcoin is 197 billion USD (as of October 7, 2020). Compared with the traditional markets that Bitcoin may disrupt (such as store of value, alternative investments, settlement networks), the total value of Bitcoin is only a fraction of a fraction.
Let us take alternative investment as an example. According to data from CAIA, the Chartered Association of Alternative Investment Analysts, the size of the alternative investment market in 2018 was USD 13.4 trillion (accounting for 12% of the USD 116 trillion global investable market). According to CAIA, if Bitcoin can occupy 5% of the alternative investment market , this would be equivalent to an increase of its market size by US$670 billion. If it can capture 10% of the market, it will expand its market size to 1.3 trillion US dollars .
We can also consider the impact of Bitcoin attracting some potential traffic from the fixed income market when investors are desperately looking for income and returns. As Cathie Wood and Chamath Palihapitiya emphasized, as global central banks lower their benchmark interest rates to near, equal to or even below zero, interest in alternative investments such as Bitcoin and other digital assets may increase.
The traditional method of investing in retirement is 60% stocks and 40% bonds. If your goal is an annual rate of return of 10%, you can successfully achieve your goal in the 1980s, 1990s and 00s. It won’t be possible anymore… now the debt yield has fallen to zero . Will the 40% return on investment become zero? What do we use instead of bonds?
One idea might be to increase exposure to alternative assets . Cryptocurrency, cars, artwork, baseball cards, etc. Most people’s; alternative investment ratio is 0-5%. If the bond interest continues to be zero, this allocation ratio may change…it’s a mathematical problem.
Chamath Palihapitiya, founder of venture capital firm Social Capital
According to data released by the CAIA Association, the size of non-US dollar and US dollar bonds in 2018 was US$50.3 trillion. If 1% of bond investment (measured by the CAIA value) flows to Bitcoin, it is equivalent to an increase in the market value of Bitcoin by $500 billion .
Although this is a simplified algorithm, the purpose of this hypothesis is to study the potential asymmetry of Bitcoin. In addition to the lack of historical correlation with other assets, this potential may also become an attractive factor for investors.
Tied together
The participation of traditional institutions in Bitcoin has reached the highest level to date. As Bitcoin becomes more and more intertwined with traditional markets , external events may have an increasing impact on Bitcoin, especially if Bitcoin’s value narrative is integrated into a single use case. In other words, given this underlying trend, if Bitcoin becomes more relevant to certain assets, the return on diversification of Bitcoin’s portfolio relative to certain assets may decline.
But fundamentally speaking, Bitcoin will not be affected by the long-term economic disadvantages that other assets may face in the coming months and years. Combined with its multi-level value narrative, continuous retail investment interest, and the interesting influence of growing institutional sentiment, it may become a potentially useful supplementary investment product that has no correlation with other assets.
Incremental benefit
In order to obtain higher returns and diversification effects from certain conventional alternative investments, investors generally must accept certain restrictions, such as reduced liquidity, limited availability, and high fees. Bitcoin allows currency holders to supplement their illiquid alternative investments with another liquid, accessible, and low-cost asset, thereby bringing similar benefits in the portfolio.
Liquidity . Bitcoin can be traded 24/7, and the transaction volume is large (as of July 2020, the daily transaction volume is from 200 million US dollars to 12.4 billion US dollars), relatively easy to enter and exit, and the price is not expensive, and its return rate is easy to observe . Depending on the source of exposure to Bitcoin, there is no lock-in restriction that prevents it from being sold immediately. Bitcoin can provide investors with flexibility to meet unforeseen liquidity needs, make short-term tactical decisions, and rebalance investment portfolios.
Accessibility . The availability of certain alternative investments is also restricted. The most profitable alternative investment options (for example, venture capital and private equity, real estate, art, and collectibles) may be reserved for the largest institutional investors. Bitcoin is unique because its accessibility is very democratic. Although certain entry and exit ramps restrict access to permissions (for example, limited to people in a given area or those who are willing to perform customer identity verification KYC), Bitcoin itself does not depend on the investor’s background or geographic location It is divided into three, six, nine, etc., anyone who has a mobile phone or computer and can connect to the Internet can openly obtain bitcoin.
Low cost . Alternative investments may be accompanied by costs that reduce the net income of investors, such as management fees and performance fees. The only fees associated with direct investment in Bitcoin are transaction costs and asset custody costs using third-party custody providers. In addition, similar to natural resources such as oil or commodities such as gold, Bitcoin also has a considerable futures and options market . Investors can use Bitcoin futures to replicate their “physical” exposure to Bitcoin.
Impact on traditional investment portfolios
So far, we have discussed the qualitative explanations behind considering the rationale behind the allocation of funds to Bitcoin, and we have also demonstrated the quantitative impact of incorporating Bitcoin into investment portfolios from a historical perspective.
From January 2015 to September 2020, if you allocate capital to Bitcoin in a traditional 60/40 stock and fixed income portfolio and rebalance your assets every quarter, the risk-adjusted return measured by the Sharpe ratio will increase by as much as 34% . The highest (3%) investment portfolio allocated to Bitcoin has an annualized return rate of 341 basis points higher. Although the volatility of the Bitcoin portfolio is also greater, the increase in volatility is significantly lower than the increase in returns. Unexpectedly, the maximum drop (the maximum loss of the portfolio from peak to trough in a given period) of all portfolios with Bitcoin exposure was also slightly lower.
In the chart below, we summarize the impact of different allocation ratios to Bitcoin on the annualized return and cumulative excess return of the investment portfolio, annualized volatility, and risk-adjusted return, depending on the investment time ( As of the current time of 2020, the longest shall not exceed 5 years), of which all holding periods are as of September 2020.
We evaluated the impact of 1%, 2%, and 3% to Bitcoin in a 60/40 ratio stock and fixed income portfolio. We have adopted iShares MSCI ACWI ETF (lACWI) funds including stocks in developed and emerging markets as proxy parameters for global stocks . We use Vanguard Total Bond Market ETF (BND) as the proxy parameter for the USD-denominated bond market. We use the money from the rich achievable bit index F idelity Bitcoin Index data to indicate bitcoin portfolio. The index started on December 31, 2014, which is why our analysis started in early 2015.
We use the total return calculation, assuming that all dividends are reinvested. However, we did not deduct the expenses related to the construction and maintenance of the investment portfolio in our hypothetical analysis. Bitcoin proceeds are not included in hard forks or airdrops. The portfolio is assumed to be rebalanced on a quarterly basis.
Portfolio summary indicators (January 2015 to September 2020)
In all the time periods shown here (as of September 2020), the annualized return of the investment portfolio allocated to Bitcoin exceeds the return of the investment portfolio not allocated to Bitcoin . As we mentioned before, the volatility of the investment portfolio allocated to Bitcoin has also increased, but the increase is lower than the increase in income, resulting in a risk-adjusted return that increases with the increase in Bitcoin risk exposure .
to sum up
If investors consider Bitcoin as a component of alternative investment solutions , this may be beneficial, because in the environment of high stock valuations and low returns of listed companies, people’s interest in alternative investment solutions is increasing day by day, and funding is possible Flow from fixed income assets to other asset classes.
The lack of correlation between early Bitcoin and other assets may be partly due to the retail-driven market , the separation of Bitcoin from the traditional market, and the lack of overlap between traditional and institutional players in the Bitcoin market. The growing institutional investor base in the Bitcoin market may lead to an increase in its relevance to other assets, depending on their narrative of the value of Bitcoin.
But there are some reasons why Bitcoin can continue to serve as a portfolio diversification and return enhancement tool. It is worth noting that the factors that explain the returns of Bitcoin are different from the factors that explain the returns of other asset classes. Bitcoin’s fundamentals are relatively unaffected by the economic impact caused by the new crown pneumonia epidemic, because its function is not based on profitability or production volume, and Bitcoin is natively digital . Bitcoin is also unique in that it continues to be affected by the sentiments of retail investors , and it can take advantage of the changes in the way retail investors interact with the traditional market and the way they obtain consumer financial information, as well as the transfer of wealth to millennials in the next ten years. Doubled in value.
Our report explores the reasons why investors believe that Bitcoin can play a similar role as other alternative investments in the portfolio. A simpler explanation is that Bitcoin is simply not suitable to be defined as an asset class (as described by Spencer Bogart, general partner of Blockchain Capital: Bitcoin is a platypus). Bitcoin’s value narrative also shows dynamic changes, making it difficult to define (called “alternative investment” is a simple approach).
At present, in terms of market size and transaction volume, Bitcoin is a very small asset and is considered an independent asset class in the strategic allocation of investment portfolios. However, as Bitcoin grows and matures, and investors understand its characteristics, Bitcoin, which is currently classified as an alternative investment , may gradually mature and become an independent asset class. Independence and alternative are not necessarily mutually exclusive-depending on the investor, many separate asset classes (for example, commodities, real estate, infrastructure) can be classified as alternative investments at the same time.
Adhering to conservatism and allocating capital to “new” institutional investment categories, you risk missing improvements in diversification, and you may miss the generous initial return .
Donald R. Chambers, CAIA, Keith H. Black, CFA, CAIA, Nelson J. Lacey, CFA
