Digital assets: a real asset for portfolio diversification

In 2021, the first ETFs (Exchange Traded Funds) on cryptocurrencies listed in Canada were launched, following the dazzling success of Grayscale Investments’ funds, whose assets under management grew to several tens of billions of USD in 2020. First Morgan Stanley and now Goldman Sachs are offering their clients access to Ethereum investing via the Galaxy Digital fund. Goldman Sachs started listing the first NDOs (non-deliverable options) on cryptocurrencies in March.

So, let’s try to get a clearer picture of the underlying motivations of institutional investors in this article by looking at the good reasons to include cryptocurrencies in your asset allocation.

Boosting portfolio returns

Since the 2008 crisis, accommodative monetary policies by central banks have led to an unprecedented decline in interest rates making it increasingly difficult to offer positive returns on traditional asset classes (stocks and bonds). Today, under the pressure of tighter monetary policies and inflation at a 30-year high, financial assets are under severe pressure.

In this context, cryptocurrencies are benefiting as a whole from investors’ infatuation with so-called “alternative” asset classes and their ability to deliver alpha over the long term, with 8% of French people having already invested in them¹.

More specifically, digital assets represent one of the few asset classes still capable of boosting a portfolio’s return per unit of risk when intelligently integrated into a diversified investment strategy.

According to Fidelity’s September figures, a 5% allocation to Bitcoin in a diversified portfolio of 60% stocks and 40% bonds improves the Sharpe ratio from 1.03 to 1.43.

Reducing risk exposure through diversification

All other things being equal, the more diversified an investment portfolio is, and the more the assets in it are decorrelated from each other, the lower the specific risk of each asset.

Where traditional asset allocations simply diversify their portfolio with stocks, bonds, commodities and currencies, modern asset allocations take diversification a step further by also incorporating digital assets such as cryptocurrencies.

By adding this new asset class to one’s allocation, it is thus possible to build an investment portfolio that is more resilient to financial market fluctuations. According to Fidelity, a 1% to 5% allocation to Bitcoin would appear to be optimal for managers who want to diversify their portfolio while limiting their exposure to sharp corrections. If integrated wisely and in the right proportions, cryptocurrencies have their place in a wisely managed portfolio.

What’s more, cryptocurrencies offer a far more liquid diversification option than most alternative investments. Today, this asset class has a market capitalisation of USD 2 trillion², surpassing the telecom industry. Indeed, it is clear that selling or buying back cryptocurrencies to rebalance your investment portfolio is much more practical and economical than doing the same with art or collectibles, for example.

Protecting your wealth from inflation

Getting a positive return is not enough to increase the value of your assets. Indeed, in order to grow richer, the nominal return obtained must be higher than inflation.

While most government-issued “fiat” currencies lose value over time due to inflation, cryptocurrencies generally escape this inflationary penalty. And for good reason, unlike traditional currencies, these digital currencies are by nature deflationary, like Bitcoin (the quantity of units in circulation being planned in advance and limited), or not very inflationary, like Ethereum, which has a mechanism for the continual destruction of Ethereum, the “gas burn”.

Thus, while currencies may fall in value as central banks create money to continually fund economic stimulus packages, cryptocurrencies such as Bitcoin can take advantage of their “safe haven” status and play their full role as a “store of value”.

Although assets such as equities are by nature already relatively immune to inflation, investing a fraction of one’s monetary holdings in a basket of cryptocurrencies can avoid the European Central Bank’s 2% inflation target, and at the same time protect against any risk of inflationary spiral.

Of course, commodities also offer good protection against inflation, and gold has been incorporated into many investment strategies because of the insurance it offers against the loss of currency value. Unfortunately, when a commodity is not perishable, its storage cost often replaces all or part of the negative effects of inflation.

With cryptocurrencies, however, the storage costs and problems associated with commodities disappear because of their digital and highly secure nature. Put another way, holding digital assets allows you to hedge against inflation without incurring large management fees.

Whether you want to boost your portfolio’s return, reduce your risk exposure through better diversification or protect your wealth from inflation, whatever your primary motivation, the Specialised Professional Funds managed by Arquant Capital are the solution to facilitate your investments in digital assets!

*ADAN & KPMG study Crypto in France: sector structure and adoption by the general public
¹Ibid
² coinmarketcap.com, data as of April 2022

Eron Angjele, Co-Founder and CEO – Arquant Capital