Could Bitcoin replace fixed income allocations in some portfolios?

Lower-yielding fixed income allocations often puzzle asset managers, however, they are an important component of most portfolios. Fixed income allocations serve to provide a more consistent return, albeit with a small overall impact on portfolio ROI (return on investment) .

Therefore, in order to improve their return on investment, some traditional fund managers have begun to turn their attention to Bitcoin, placing their funds in higher risk-adjusted returns.

Traditionally, portfolio managers would choose some precious metals as a “store of value” and as a promising return. However, in the current situation, Bitcoin seems to be outperforming gold, and its correlation spread with gold is also increasing .

The price of Bitcoin started to recover in July 2020 and is currently considered to be rebounding towards the previous high. Due to the huge volatility and the relatively low reserves of Bitcoin on spot exchanges, there may be several adjustments during the intraday or weekly period, but the opening and closing prices seem to remain stable again.

According to Woobull Charts, Bitcoin has the highest risk-adjusted return compared to non-cryptocurrency traditional assets such as gold, U.S. stocks, real estate, bonds and emerging market currencies. The return of U.S. stocks has been close to Bitcoin's return in a month or two, but this is the closest it has ever been. Bitcoin's ROI has always been ahead of gold, real estate and stocks.

This makes it a profitable addition to a modern portfolio, and to examine its relevance, let’s consider Bitcoin’s Modern Portfolio Theory. Modern Portfolio Theory is a theory about how risk-averse investors can construct a portfolio to maximize their expected return within a given market risk.

It presents a framework showing how investors can reduce overall risk while maximizing returns by holding a diversified portfolio consisting primarily of non-correlated assets, with the first on a modern asset manager’s list likely to be Bitcoin, U.S. stocks, or gold .

Unlike looking at the risk-return characteristics of each asset individually, the above theory evaluates the risk and return of the broader portfolio based on the cumulative interactions between the portfolio assets. Since the assets are uncorrelated, the performance of the portfolio will not be biased towards the performance of a specific asset. Ironically, a 1%-2% exposure to Bitcoin (if not other cryptocurrencies) does not reduce the overall ROI of fixed income, but instead provides a higher risk-adjusted return.

For institutional investors, 1%-2% of funds may be equivalent to thousands or nearly 10,000 BTC, which may be the key reason why institutions hoard BTC at $14,000-15,000. In addition to providing the highest risk-adjusted returns, BTC also provides portfolio managers with a variety of options when selecting uncorrelated assets to add to the portfolio.

BTC’s correlation with stocks hit zero in the last week of October 2020 , and the asset has become increasingly uncorrelated with the S&P 500 since then.

In the long run, a declining correlation with the S&P 500 could benefit BTC and its price, as institutions interested in higher risk-adjusted returns may allocate Bitcoin to their portfolios instead of lower-yielding fixed-income securities.