Bitcoin Investment Portfolio Diversification to Attract Institutional Investors per Western Carolina University Study
Study Considers Bitcoin as an Attractive Investment for Diversification Purposes
A Bitcoin study conducted by Lawrence J. Trautman and Taft Dorman, whom are from the Western Carolina University, have concluded that Bitcoin can be considered as an investment option, especially for those seeking to diversify their portfolios. Matter of fact, the duo sees the crypto giant as “attractive” because of its “low correlation with equities markets.”
The goal of the study was to examine Bitcoin’s history up until halfway through 2018 and to form a comparison analysis in which the giant would be assessed against traditional asset classes such as Dow Jones 30 Industrial Average; S&P 5000; BASDAQ; Russell 2000; and gold to name a few. When trying to create the comparison, both authors found it to be rather difficult namely because of Bitcoin’s volatile nature and very low liquidity, but still managed to obtain results.
A Little on the Portfolio Theory and Correlation of Asset Classes
An interesting concept that was brought to readers’ attention is that of the Portfolio Theory, which indicates a methodology to investing. In particular, it advises investors to consider the utility-maximizing investment strategy, which emphasizes greatly on mean-variance efficient. There seems to be two parts to investing: “minimizing risk and maximizing expected return”.
Based on the claims made, given an asset varies a lot in prices, investors can then invest in assets that have “uncorrelated price movements”, which could also supposedly increase expected returns. The duo argues the following:
“Each individual security within an investor’s portfolio contributes to total portfolio variance, depending on its co-movement with other assets the investor chooses to hold in the portfolio.”
This being said, it was found that positively correlated assets ended up with negative effects, and vice versa. Therefore, it is ideal to invest in assets that have no relationship whatsoever.
An exhibit dubbed,
“Relationship between Portfolio Standard Deviation and Diversification, showed that the less diverse one’s portfolio was, the more risk was tied to it. As investors continue to diversify their portfolios, the total risk exponentially decays, with some (little compared to the former) risk tied to it.”
Bitcoin As an Asset Class
In understanding whether Bitcoin deserves to be considered as an asset class of its own, the duo supposedly compiled weekly excess returns for each traditional asset class and the cryptocurrency. Then they took the correlation between the traditional asset and Bitcoin to see whether some association exists.
As mentioned before, the researchers did not see too much correlation. Furthermore, the assessed each assets’ performance level only to find that Bitcoin beat them “with a 31-quarter average weekly excess return of 4.28%”. Simply put, Bitcoin has the ability to give investors an annual return rate of over 200%!
The problem, as we might have all witnessed, is Bitcoin’s high variance, which measures the degree of risk of an investment. This however does not imply that variance is completely bad, as it also gives hints on the potential returns one could make.
An exhibit dubbed,
“Correlation of Asset Classes Weekly Excess Returns, showed that correlation between Bitcoin and other asset classes were much lower compared to when the traditional assets were calculated among themselves. Despite its high variance, the fact that it was uncorrelated makes it attractive.”
To read the entire study, feel free to check out here.