Between 1% and 5%, that’s what the experts seem to recommend when it comes to the amount of Bitcoin a typical portfolio should hold.
According to research by Morgan Stanley, even a 2.5% portfolio allocation into Bitcoin from a typical 60/40 stock and bond portfolio, could see an increase of as much as 0.48 in its Sharpe Ratio (higher is better).
And although Bitcoin’s portfolio diversification credentials have long been viewed suspiciously by traditional portfolio managers, last week, it staked its credibility by moving opposite to the broader markets.
Although stocks and Bitcoin appeared to move in lockstep in September, as markets suffered their worst rout in weeks as energy prices soared, the benchmark cryptocurrency has since moved in the opposite direction.
Since the start of September, the S&P 500 has shed some 5% while Bitcoin has gained 10% and that decoupling could revive one of the longstanding promises of the cryptocurrency – diversification.
Bitcoin proponents have long held that the cryptocurrency can serve as a hedge to protect investment portfolios when equities selloff during times of uncertainty and turmoil.
The ability to act as ballast to a portfolio is in high demand right now as the macroeconomic landscape becomes increasingly uncertain.
U.S. Treasuries, typically relied on to perform a stabilizing role, have failed to act as a diversification tool against equities, due to a period of ultra-low yields thanks to central bank intervention as well as rising inflation.
But the path to diversification has not been smooth. Bitcoin remains highly speculative in nature, driven more by narrative than any technical model and can demonstrate negative correlation for short periods followed by periods of strong correlation with other risk assets.
For Bitcoin or indeed any cryptocurrency to act as a suitable hedge to a portfolio, investors will need to be far more proactive with their asset allocation than the typical 60/40 would have allowed.
The prevailing sentiment (for now) appears to have returned to Bitcoin’s role as an inflation-hedge, with stronger correlation to hard assets such as gold.
But that narrative can change in an instant and the cryptocurrency could just as readily be associated with tech or growth stocks in a heartbeat.