Author: Noelle Acheson
Translation: Olivia
My favorite of all the famous quotes that Mark Twain has said is “It’s not that unknown things will get you into trouble, but you know that it is not.”
In the turmoil of 2020, many market “truths” have become myths. And many trusted investment sayings no longer make sense.
One question has troubled me for a long time: how many financial advisors still recommend a 60/40 portfolio balance between stocks and bonds. In theory, stocks will bring you growth, and bonds will bring you income and provide a buffer when stocks fall. If you want to protect your capital during the investment process, then I tell you that this is a diversified investment strategy for you.
Decentralization itself has not been tested too much. But whether you agree with chaos theory or just enjoy a balanced investment approach, diversification is a very good rule of thumb.
This is what we need to consider when we diversify our investments.
Why diversify investment?
The idea is that diversified investment will diversify risk. A strategy that harms one asset may be beneficial to another asset, or at least it will not cause much harm to it. An asset may have a unique value driver that makes it unique. Holding positions in low-risk, high-liquidity products allows investors to make up for emergencies and take advantage of other investment opportunities when unexpected situations occur.
All of this has been established to a large extent. What needs to be questioned is the assumption that diversified investment should be spread between stocks and bonds.
One of the main reasons for splitting stock/bond allocation is to hedge risk. Traditionally, the trend of stocks and bonds has been reversed. In an economic downturn, the central bank will lower interest rates to revive the economy. This will push up bond prices, thereby partially offsetting the decline in stocks, resulting in better performance than unbalanced funds.
Since the 2008 crisis, this relationship has been broken. In fact, as shown in the chart below, in the past 20 years, stocks (represented by the Standard & Poor’s 500 Index) have performed better than balanced funds (represented by the Vanguard Balanced Index) over the rolling year.
Why is this? First, the central bank no longer uses interest rates as a tool to resist recession. Although negative interest rates are possible, they are unlikely to recover the economy enough to reverse the stock market that has fallen due to the recession.
And, as we have seen this year , the stock market can continue to rise even in the event of an economic downturn. Driven by lower interest rates and a large amount of new funds chasing assets, stock valuations have become decoupled from expected returns some time ago.
Therefore, as long as the central bank maintains its current policies, there is no reason to believe that the stock market will fall significantly this year, nor is there any reason to believe that bonds will rise. And it’s hard to imagine how they can withdraw from their current strategy without causing significant losses to borrowers (including the government). So, where should we avoid risks?
Another reason to hold a portion of bonds in a portfolio is to guarantee income. This has been replaced by record low interest rates. As for the “safety” aspect of holding government bonds, the sovereign debt/GDP ratio is at a historic high. No one hopes that the US government will default-but it is more of trust than financial principles. The persistence of trust may be another hypothesis that needs to be studied.
You may have heard of it before: Government bonds used to provide risk-free interest. Now they provide no interest risk.
So why do financial advisors still recommend bond/equity balances?
Why hedge?
Another potential reason is hedging volatility. In theory, stocks are more volatile than bonds because their valuation depends on more variables, but in practice, bonds are often more volatile than stocks, as shown in this 30-day volatility chart of the TLT long-term bond index :
Therefore, the reason for the 60/40 separation of equity and debt, whether as a source of income or as a hedging method, no longer has any meaning. Even just adjusting the ratio did not achieve the actual goal. The basic weaknesses of stocks and bonds now overlap.
More importantly, there is no reason to expect things to return to square one. Even if the United States does not have a divided government, it is difficult to implement sufficient fiscal expansion to maintain sustained economic development. More likely, expansionary monetary policy will become the new normal. This will cause bond yields to fall, stock prices to stabilize or rise, and deficits to inflate.
This raises the question: What should the portfolio hedge?
The traditional portfolio hedge is the business cycle. In years of economic growth, stocks perform well, and in years of economic contraction, bonds intervene. However, the business cycle no longer exists. The signal from interest rates in the past has been emptied by the central bank, which means that investment managers who still believe in the business cycle are acting blindly.
What is the biggest investment risk facing savers today?
It is currency devaluation. The expansionary monetary policy in the past counted on the resulting economic growth to absorb new money supply. The numerator (GDP) and denominator (the amount of currency in circulation) grow together so that each currency unit can at least maintain its value. Now, the influx of new funds into economic development is just to maintain economic stability, which keeps the numerator constant (or even decreases) while the denominator rises sharply. As a result, the value of each currency unit is falling.
The depreciation of the base currency will have an impact on the value of stocks and bonds in the long-term investment portfolio. From the perspective of purchasing power, the wealth of savers is not as good as before. So in fact, the 60/40 allocation ratio did not help them.
In an environment where currency depreciation looks increasingly certain, a new type of portfolio hedging is necessary.
In this case, the ideal hedging tool is an asset that is immune to monetary policy and economic fluctuations. Assets that do not rely on earnings to value and whose supply cannot be manipulated.
Gold is such an asset. Bitcoin (BTC, +2.82%) is another compound currency whose supply is more inelastic.
Paul Tudor Jones (Paul Tudor Jones), Michael Saler (MicroStrategy CEO), Jack Dorsey (Square CEO) and others have boldly stated this point, and they have included Bitcoin in their portfolios and national debt , Betting on its future value as a depreciation hedge. This idea is not new.
But what is confusing is that most professional managers and consultants still recommend the bond/stock split, which has no meaning. The fundamentals have changed, but most portfolios are still sticking to an outdated formula.
Right now, I am not recommending investing in Bitcoin itself (anything in this article is not investment advice). What I want to say is that in the face of new realities, investors and advisers need to question old assumptions. They need to rethink the meaning of hedging and what the real long-term risks their clients face, otherwise they will be irresponsible for their clients’ investment funds.
In times of uncertainty, it is understandable that we adhere to the old rules. But in today’s changing circumstances, we are accustomed to seeking comfort from familiar things. However, it is when the current strategy no longer makes sense that we need to question the assumptions. In modern times, there are few people who have so much uncertainty about future progress. In this era, the role of professional investors and financial advisors is more critical than ever, because depositors not only urgently need guidance, but also protection.
Therefore, it is increasingly necessary for us to rethink our portfolio management strategies, even for conservative portfolios. If we do not do this, the risks will not only be in terms of profit.
Getting better
Genesis (a subsidiary of DCG and also the parent company of CoinDesk) released its third quarter digital asset market report. The report showed significant growth in loan and transaction volume and highlighted an interesting industry shift.
New loans amounted to US$5.2 billion, more than double the US$2.2 billion in the second quarter. The increase was mainly due to loans in ETH (ETH, +2.96%), cash and altcoins – BTC accounted for 51% of outstanding loans It drops to 41%. The number of unique institutional lenders in the third quarter increased by 47% from the second quarter.
Spot trading volume increased by about 14% compared with the second quarter, and the rising trend of electronic trading volume was obvious. In the first full quarter of the Derivatives Trading Department, bilateral derivatives trading volume exceeded US$1 billion.
These figures outline two trends:
1) Institutions are increasingly interested in crypto assets other than Bitcoin, which is mainly driven by the rate of return of the DeFi protocol. The liquidity of these assets is usually insufficient, causing institutions to be unable to have a strong interest in them. However, ongoing experiments in this field and investors show that eventually there will be a larger number of innovative services that can handle a larger number of risks under controllable risks. And strategy.
2) Institutional investors continue to develop increasingly complex crypto trading and investment strategies. This highlights that the crypto asset market is growing, which will bring in more institutional funds, and these funds will in turn encourage institutions such as Chuangshi to further develop products and services. This virtuous circle is pushing the market to where it should be: a highly liquid and mature alternative asset market, which will more widely influence how professional investors conduct asset allocation.
The report also revealed that Genesis is developing a set of products and services aimed at facilitating the flow of institutional funds into the crypto market and surrounding markets: lending API, allowing deposit aggregators to earn income, capital introduction and fund management, and agency transactions. These, together with the custody service launched in the third quarter, will further strengthen its growing network of market investors and infrastructure participants.
This may indicate that the crypto market is becoming more integrated: a one-stop shop designed to help customers with all aspects of crypto asset management has emerged. An often mentioned obstacle to crypto investment is the decentralization of the industry and the relative complexity involved in holding positions in crypto assets. Clearing these barriers will make it easier for professional investors to enter the field, and gaining liquidity may encourage some people to invest heavily.
Genesis will not be the only driving force, and we may see other well-known companies competing to increase their agency-oriented services. This may lead to a series of mergers and acquisitions and the recruitment of more strategic talents from traditional markets. Either way, the industry will benefit from an experienced and mature market infrastructure.
Does anyone know what happened?
This week will undoubtedly be recorded in the annals of history. It will be a surreal week in terms of events driving the market.
First of all, Tuesday is the longest day in my memory. In fact, at the time of writing this article, I feel that Tuesday is not over yet.
Second, stocks seem to like uncertainty. Who knows.
Third, Bitcoin suddenly appeared at a chaotic moment, introducing election results and political uncertainty into the market.
Bitcoin’s performance this week has consolidated its position among the best performing currencies this year (XLM, +1.18%). However, the S&P 500 index is on a good show – as of November, its index has soared and accounted for most of the positive performance this year.
CHAIN LINKS
Veteran investor and Chief Investment Officer of Miller Value Partners, Bill Miller, revealed in an interview with CNBC this week that half of his MVP1 hedge fund invests in Bitcoin. Conclusion: Another investor made the concern about inflation as one of the reasons professional investors should pay attention to Bitcoin. It can also be seen from Miller’s statement that the risk of Bitcoin zeroing is “lower than ever.” He is talking about asymmetric risk: the probability of Bitcoin returning to zero (100% loss) is much lower than the probability that it will provide a return of 200% or more.
It seems that evidence is needed to prove that this rise in bitcoin is very different from the last rise in bitcoin prices that exceeded $15,000 in 2017, and Google’s search for “bitcoin” is also soaring. Conclusion: This means that the hype is much lower-key this time (although there is some arrogance on encrypted Twitter). This also shows that fewer and fewer “newbies” are entering the market-buyers who push up the price of Bitcoin do not need Google, which means that they are not only attracted by Bitcoin’s performance.
Square ‘s revenue in the third quarter of 2020 was $1.63 billion, and the gross profit of its cash application bitcoin service was $32 million. The year-on-year growth was about 1000% and 1400% respectively. Conclusion: Selling bitcoins in the cash app made Square less than 2% of profits. Compared with Square’s overall business, the profit margin is very low, and Square’s business profit margin is much higher. But the strong growth indicates that the retail industry’s demand for Bitcoin has increased significantly, which can partly explain the growth of BTC addresses, and of course it can also explain the price momentum.
Fidelity Digital Assets (FDA) is hiring more than 20 engineers. The company stated in an article that it is working to improve its existing bitcoin custody and execution services and create new products. Summary: This recruitment hints at their expansion plan for digital asset services. Given the influence of the FDA platform, it can broaden the channels for institutional investors.
This article does not pay too much attention to Ethereum (ETH), which is the native token of the Ethereum blockchain because it lags behind Bitcoin in market capitalization, liquidity, derivatives, and the number of on-chains. However, its infrastructure is maturing, and it is undergoing major technological changes, which will affect its value proposition. More importantly, it can be used as a good decentralizer for the allocation of encrypted assets in the investment portfolio. This year, it has performed significantly better than Bitcoin (220%/117%).
The deposit contract of Ethereum 2.0 has been launched, marking the “point of no return” of the network’s migration to the PoS blockchain , which aims to enhance scalability and reduce costs. Now, the release time of ETH 2.0 is set to December 1st, if 16,384 validators will deposit the equivalent of 524288 ETH into the contract by then. Summary: The deposit contract allows 32 ETH to be deposited on the new chain. It will provide an annualized return of up to 20% and will serve as a one-way bridge between the current chain and the new chain. Vitalik Buterin, the creator of Ethereum, has sent 3,200 emails in exchange for 100 deposit contracts.
Encrypted asset platform FTX stated that they will launch a deposit-based ETH-based derivative (called “Beacon chain ether”, or BETH), which can be used as a settlement for Beacon ETH after the withdrawal is enabled next year. Summary: This is just a hint of innovation, as new products and use cases emerge. It can also increase interest in betting on ETH, because it theoretically provides liquidity for participants and removes illiquidity barriers for some investors.
In October, as the enthusiasm for decentralized finance cooled, the income of miners processing transactions on the Ethereum blockchain was reduced by more than half, and transaction fees dropped by more than 60%. Summary: The drop in fees may not be good news for miners but it is good for the Ethereum network because it shows that congestion is fading.
