Andrew Milligan, former head of strategy at Aberdeen Standard Investments, questions the notion that cryptocurrencies have a roll in institutional portfolios – at least on the advice of crypto bulls.
So many articles from investment banks, asset managers and digital experts have extolled the virtues of investing in bitcoin. Before doing so, I will reflect on two lessons which I learned the hard way during my career.
Always consider: why are they telling me this? Are they truly independent or are they trying to sell me something? Then: do they have statistics to back up what they say or are the arguments self-serving platitudes?
Only after answering such questions can we decide whether bitcoin plays a useful role in a portfolio.
Names matter. I suggest that rather than using the term ‘digital currency’ the words ‘digital commodity’ would be better. Some central banks have issued digital currencies, say in China and the Bahamas, but these are very much government creations for the benefit of all citizens. Stable coins such as Facebook’s diem (libra) will necessarily be publicly regulated to protect the banking system. Bitcoin, dogecoin, ethereum and the like are privately issued; indeed mined would be a better expression. They are created using a massive amount of computer power, not only equivalent to the energy consumption of a mid-sized economy but also highly polluting as most of the miners are based in China and Russia. What are your ESG credentials as a potential holder?
The classic portfolio
Let us approach digital commodities from the perspective of creating a portfolio. The classic 60-40 type portfolio is designed to minimise drawdowns while generating a positive return. It would include an array of risk-facing assets (equity, real estate, etc) which benefit from a range of cash flows (profits, rents, etc). These asset would stand alongside a range of defensive assets (bonds, cash) which provide both income and hedging characteristics.
More sophisticated multi-asset portfolios include a broader array of assets and dynamic asset allocation techniques – but the principles are the same: which risk premia do I wish to benefit from (equity, illiquidity, credit, etc)?
I can improve a portfolio by seeking assets with different characteristics, preferably not moving in line with traditional markets. An example might be infrastructure, benefitting from steady cash flows and long maturities.
On that basis, how might bitcoin fit into a portfolio? Many argue that ‘Digital Gold’ will necessarily have different risk/return characteristics; indeed some say that bitcoin represents the most uncorrelated asset in the market. At this point, we move from words to statistics, and discover that bitcoin is merely a highly leveraged risk-facing commodity.
Examining charts clearly shows that bitcoin is correlated with movements in such assets as Tesla, the Nasdaq, or risk-on/risk-off market moves. Bitcoin does not provide protection against…
Read more:Bitcoin is no gold