Adding crypto to a diversified portfolio

I. Blockchain & crypto currencies: a new asset class in the making

Crypto assets gained major public attention in recent years, as their performance significantly outpaced all asset classes worldwide. Bitcoin increased 1338% in 2017 alone for example (source: crypto compare).

The growing adoption of the disruptive blockchain technology also fostered a wave of new crypto assets and blockchain related projects, leading investors to wonder if those digital assets could be considered as an eligible asset class given their potential for higher long term returns.

An asset class, to be considered as such, requires in our opinion, several conditions to be met:

  • asset ownership protection.
  • sufficient liquidity.
  • measurable intrinsic value.
  • positive return compensating for the investment risk.

Do crypto assets fulfil those criteria?
Given their nascent investment status and the regularly moving landscape surrounding them, this question cannot yet be definitively answered.

However, recent market developments have been constructive and point in the right direction:

  • new ser v ice prov iders are emerging to solve long standing custody issues.
  • underlying liquidity for crypto assets increased significantly over the last year.
  • intrinsic value methods are better understood (mining costs approach, adoption & velocity).
  • positive returns can be achieved through higher prices based on a rising intrinsic value.

By the time market participants agree that those questions have been addressed and solved, digital assets might well have already become a mainstream investment in most investors’ portfolios!

Does crypto makes sense in a diversified portfolio?
A potential performance booster.

A mere 5% exposure of Bitcoin (as a proxy to crypto assets) would have allowed a 55% / 40% / 5% Bitcoin diversified portfolio outperform a traditional 60% equities / 40% equities (without Bitcoin) by a staggering 9.4% annual return since May 2011.

A higher risk fairly remunerated

Adding a 5% crypto asset exposure has increased portfolio volatility during the measuring period. However, the higher volatility was fairly compensated by a higher return as shown on the below risk / return matrix.

II. Back-testing of a Fund of Funds strategy

A fund of fund strategy will aim at providing exposure to crypto assets at a lower risk, by implementing an effective diversification of investment through the selection and active monitoring of best-of-class managers acros s a number of di f ferent strategies.

We have performed for information purposes a back-testing (blue line) using a model portfolio based on the core funds currently included in Block Asset Management’s flagship fund of funds.

We have then linked the simulated
historical return to the return achieved by the fund since inception in January 2018 (red line, based on the fund’s NAV). We have also added Bitcoin’s performance as a market reference – even if Block Asset Management’s flagship fund of funds does not intend to outperform Bitcoin and rather aims at providing exposure to the larger blockchain & crypto asset class (while reducing performance drawdowns and smoothing month-to-month volatility).

The performance table shows that the back-tested portfolio tends to incur lower drawdowns that the Bitcoin. For example, the maximal drawdown experienced for BAM’s flagship fund (-25,1%) was half the Bitcoin drawdown (-49.9%) in 2018.

Please note that no investment conclusions should be drawn from this simulation. Past performance should not be used as an indicator of future returns. In addition, the back-tested period is rather limited and the model portfolio will change over time and may therefore not lead to the same results going forward. Finally, the back-tested period (blue-line) shows back-tested returns which are gross of management fees.

The information does not constitute an offer of products or services analogous to a public offering or any other sales or marketing activity or solicitation to buy or sell securities or encouragement or advice to make a particular investment or to arbitrage securities by any person in any jurisdiction in which such an offer or invitation would be considered illegal or in which the person proposing this offer or invitation is not qualified to do so or to any person to whom it is illegal to propose such an offer or invitation. The information presented has been obtained or drawn, in whole or in part, from sources considered to be reliable. Block Asset Management declines all liability regarding its accuracy or completeness. The information may be removed or amended at any time without prior notice. Past performance is not an indication or guarantee of future performance. Block Asset Management does not assume any liability or give any guarantee as to future performance with regard to the products under its management. Any person who is not permitted to invest in Block Asset Management’s flagship fund of funds, for any reason but related, for example, to his nationality place of residence, or any person who is not qualified as a qualified investor within the meaning of the Luxembourg Law as amended of 10 July 2005 on prospectuses for securities, must refrain from consulting this document.

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