The viability of bitcoin as an investment option is a highly debated one. Market analysts remain divided on if the asset constitutes what could be regarded as a good investment to include in a portfolio. Others have simply commented that the asset poses an opportunity for investors to diversify into riskier assets. Padding up what would already be a conservative investment portfolio.
The latter school of thought is what has been presented in a recent report from The Economist regarding the opportunity an extremely volatile asset like bitcoin presents. The author, in their report, dissects the 1952 Nobel Prize-winning paper of Harry Markowitz in the Journal of Finance. Markowitz, then a young economist regarded as a genius, posited what would become known today as the “modern portfolio theory.”
The paper boiled down a composite investment portfolio to one which contains both risk-free and highly volatile assets. This way, when an asset fails, the others would remain to fill in the loss left by the former. All the while maintaining the integrity of returns in the portfolio. In addition, Markowitz put forward that the risk associated with an asset, like bitcoin, may not actually be the most important. But rather, that the volatility contributed by such a risky asset is what makes it an important addition.
Removing volatility entirely from a portfolio will no doubt lead to lower returns. This is mainly because the less risky an asset is, the lower the returns on that asset. Take an investment like bonds as an example. Bond returns usually have a 1-5% annual yield, sometimes even lower, because bonds are relatively safe assets. For investors chasing a higher return on their investments, volatile assets are a must. This is where assets like bitcoin come into the picture.
Bitcoin Returns Speaks For Itself
Though highly volatile, the returns of bitcoin have proven to be worth the risk the asset carries. Bitcoin completely embodies the theory put forward by Markowitz’s in his paper. An important addition to a portfolio with high and dependable returns. Its returns also play an important role in the inclusion of the asset in every portfolio. Despite plunging and surging at what appears to be regular intervals, the asset’s returns have outperformed almost every investment mechanism known to man today.
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The theory proposes that a portfolio features a percentage, although small, of volatile assets. The Economist points to hedge fund manager Paul Tudor Jones’ investment strategy which he had revealed earlier in the year. Jones explained that he held about 5% of his entire portfolio in bitcoin. Given that Jones is an experienced investor, it is not a long-shot to say that the portfolio is highly diversified. And in its diversity, includes an asset as volatile as bitcoin.
BTC up trading above $44,000 | Source: BTCUSD on TradingView.com
The report adds that any balanced portfolio at present requires a bitcoin position of about 1-5% of the total value. Not only due to the high returns of the asset, but portfolios that featured even a 1% position in bitcoin showed better risk-reward characteristics when compared to portfolios devoid of bitcoin investments.
In conclusion, the report puts forward that it remains unclear what is the driving force behind bitcoin’s returns. And investors are yet to settle on whether the asset presents “salvation or damnation.” However, “neither side is likely to hold 1% of their assets in it,” the report reads.
Featured image from Skalex, chart from TradingView.com