Bitcoin’s viability as an investment option is hotly debated. Market analysts are divided on whether the asset is what could be considered a good investment to include in a portfolio. Others have simply stated that the asset represents a chance for investors to diversify into riskier assets. Increasing the size of what would otherwise be a conservative investment portfolio.
The latter school of thought is supported by a recent report from The Economist on the opportunity presented by an extremely volatile asset such as bitcoin. In their report, the author dissects Harry Markowitz’s 1952 Nobel Prize-winning paper in the Journal of Finance. Markowitz, a young economist regarded as a genius at the time, proposed what is now known as the “modern portfolio theory.”
The paper reduced a composite investment portfolio to assets that are both risk-free and highly volatile. In this manner, if one asset fails, the others will continue to fill the void left by the former. All while maintaining the portfolio’s return integrity. Furthermore, Markowitz argued that the risk associated with a particular asset, such as bitcoin, may not be the most important. Rather, the volatility brought about by such a risky asset is what makes it such an important addition.
Removing volatility from a portfolio will, without a doubt, result in lower returns. This is primarily due to the fact that the lower the risk of an asset, the lower the returns on that asset. Consider bonds as an example of an investment. Bond returns typically have a 1-5 percent annual yield, and in some cases are even lower, due to the fact that bonds are relatively safe assets. Volatile assets are essential for investors seeking a higher return on their investments. This is where assets such as bitcoin come into play.
Bitcoin Returns Speak For Themselves
Despite being highly volatile, bitcoin’s returns have proven to be worth the risk the asset entails. Bitcoin fully embodies the theory advanced by Markowitz in his paper. A valuable addition to any portfolio, with high and consistent returns. Its returns are also important in deciding whether or not to include the asset in any portfolio. Despite seemingly regular dips and surges, the asset’s returns have outperformed almost every investment mechanism known to man today.
According to the theory, a portfolio should contain a small percentage of volatile assets. The Economist cites hedge fund manager Paul Tudor Jones’ investment strategy, which he disclosed earlier this year. Jones stated that bitcoin accounted for about 5% of his total portfolio. Given Jones’ experience as an investor, it is not a stretch to say that the portfolio is well-diversified. And it includes a volatile asset like bitcoin among its diversification.
According to the report, any balanced portfolio at the moment necessitates a bitcoin position worth 1-5 percent of the total value. Not only because of the asset’s high returns, but portfolios with even a 1% position in bitcoin demonstrated better risk-reward characteristics when compared to portfolios devoid of bitcoin investments.
In conclusion, the report states that it is still unclear what is driving bitcoin’s returns. Furthermore, investors have yet to decide whether the asset represents “salvation or damnation.” However, “neither side is likely to hold 1% of their assets in it,” according to the report.