Bitcoin as an asset that helps balance a portfolio

Marc Faber is an investment advisor and fund manager, famous for his "Gloom Boom Doom" Newsletter. He is a unique investor, known as "Dr. Doom" in the investment field, and often expresses his unique views in the media. Recently, in an interview with CNBC and Bloomberg, he once again claimed that the United States is about to enter a recession, and listed his evidence to illustrate the poor state of the US economy. In his speech, he hinted that investors should consider Bitcoin.

Faber says:

Speaking of how bad the economic situation has been this year (2016), I have to mention the investment situation last year (2015). Except for those who held Bitcoin, all other assets performed quite badly.

Faber famously advised his clients to get out of the stock market before the October 1987 crash, and gave some warnings leading up to the banking industry's problems in 2008. He was famously wrong sometimes too, such as when he predicted that gold prices would rise 30% in 2015.

He once asked his clients to exit the stock market a week before the 1987 stock market crash. However, many people believe that many of his predictions were correct in direction but wrong in timing. For example, he predicted that the price of gold would rise by 30% in 2015.

As a "prophet", Faber has not made any positive predictions about the price of Bitcoin. Faber briefly mentioned Bitcoin in a webinar in 2014, saying:

“I don’t know what the value of Bitcoin is. I hold gold because I want to have some cash when the system fails. But if the system crashes and the network is down, what is the value of your Bitcoin?

2014 was the worst year in Bitcoin’s history. Bloomberg published an article titled “Bitcoin was the worst performing currency in 2014”, claiming that it beat the Russian ruble and hryvnia to become the worst performing currency. However, in the past year, Bloomberg published an article claiming that “Bitcoin was the big winner in 2015”.

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Bitcoin wasn’t just the best performing “currency” of 2015. As Faber points out, it was also the best performing asset. Looking ahead to 2016, Faber told Bloomberg, “asset markets are going to crash like the Titanic.”

Bitcoin is an asset class, just like stocks, bonds, precious metals or currencies. In early 2013, Max Keiser mentioned this view in his show "The Keiser Report", and it quickly went viral. In December 2013, The Bankwatch explained on its FinTech blog why "Bitcoin is an asset, not a currency." In May 2015, the New York Stock Exchange launched the Bitcoin Price Index (NYXBT), treating it as an asset class. This is the first known Bitcoin index calculated and published by a stock exchange in the world.

Thomas Farley, President of NYSE Group, said:

“The price of Bitcoin is quickly becoming a data point that clients want to track as they consider trading, buying, selling or investing in this emerging asset class.”

One of the first lessons that investors learn is to build a strong, diversified portfolio. Diversification is one of the characteristics of a good portfolio, and it should be present in stocks, bonds, and precious metals. Ideally, when one asset falls, the other assets can make up for the loss.

While there is no guarantee that Bitcoin will continue to outperform other assets, it may be beneficial to include Bitcoin as part of a portfolio. Fidelity Investments, the world's second-largest mutual fund and financial services group, believes that diversification has the potential to improve risk-level returns.

Fidelity Investments said:

To build a diversified portfolio, you should choose assets (stocks, bonds, cash, etc.) that have different trends in returns and, ideally, whose returns generally move in opposite directions. That way, even if one part of your portfolio declines, the other parts will still have a greater chance of growth. This may offset the negative impact of poor performance of some assets on the overall portfolio.

Looking at the development trend of Bitcoin and other asset classes in 2014 and 2015, we can see that Bitcoin has an opposite trend to other assets. In 2016, many asset markets are expected to perform poorly, so more investors may pay attention to Bitcoin.

  In 2013, Marie Brière, Kim Oosterlinck, and Ariane Szafarz from Paris Dauphine University jointly wrote a research report analyzing the role of Bitcoin in portfolio diversification. They found that Bitcoin has a very low correlation with other asset classes. They also reminded investors that Bitcoin may not be suitable for inclusion in the lowest risk portfolio at the time due to its high volatility. In their report, they explained the benefits of Bitcoin for investment diversification: "From a statistical point of view, Bitcoin's rate of return shows an opposite trend to other assets, including gold, oil, and hedge funds. In addition, Bitcoin investment is attractive because it provides extremely high diversification benefits, which is due to the low correlation between Bitcoin and not only traditional financial assets, but also other investments.

The volatility of Bitcoin prices has gradually stabilized. According to Btcvol, the current 30-day price fluctuation of Bitcoin is around 3.17%, and 2013 was the most turbulent year in Bitcoin's history, with a crazy surge during the "Cyprus debt crisis" in April and a price crash caused by the Mt.Gox incident at the end of the year.

Although the current volatility of 3.17% is still considered to be beyond the normal range compared to other mainstream currencies, the 30-day volatility range of the US dollar is usually 1%-1.5%, but the volatility of other currencies has even reached 25%-50%, such as during the rapid depreciation of the Argentine Peso and Venezuelan Bolivar. In an independent research paper published by the Vienna University of Economics and Business, "Is Bitcoin Good for Portfolio Diversification", a strong argument is given to prove that "Bitcoin should be included in the optimal portfolio."

The authors of the paper, Alexander Eisl, Stephan M. Gasser and Karl Weinmayer, used a portfolio optimization method based on conditional value at risk (CVaR) to explain Bitcoin's extremely abnormal return distribution. They found that the inclusion of Bitcoin in the portfolio improved the expected return and reduced the return risk of the portfolio. However, they said in the paper that "Bitcoin's contribution to returns seems to exceed the additional risk faced by investors."

“We found that in an already well-diversified portfolio, we included Bitcoin in the effective portfolio, on average, between 1.65% and 7.69%. At this relatively low level, and given the relative volatility of Bitcoin prices, it is very beneficial to the portfolio from a liquidity perspective… Bitcoin can promote the risk-return ratio of the optimal portfolio.

In a recent report, “How to Position for a Rally in Bitcoin,” Austrian economist and investor Tuur Demeester made the same point, “It is very important to consider Bitcoin as part of a diversified portfolio.” He also explained the benefits of Bitcoin asset allocation, citing that Bitcoin “provides a counterbalance to a range of risks present in traditional investments.”

“We believe that a comprehensive portfolio should also include exposure to blockchain technology (altcoins), but with a focus on Bitcoin. This portfolio can work in three different strategies: 1. As an insurance strategy; 2. As a safe-haven hedge in a broadly speculative portfolio; 3. As an early retirement bet.

According to Demeester, even the most conservative portfolios should include 1%-2% of cryptocurrencies, especially Bitcoin. Speculative portfolios should include 2%-5%. And for investors who hope to retire early, they should hold 5%-10%. Investing in Bitcoin, like any other investment, is not without risk. Demeester wrote: "We believe that a return of 100x in 10 years is possible, but of course this is not absolutely guaranteed."

Although it is impossible to accurately predict the price of Bitcoin, Daniel Masters predicted in December 2015 that "next year, the price of Bitcoin may reach the high point of $1,100 in 2013 again, and then accelerate to $4,400 by the end of 2017." Daniel Masters is the co-founder of Global Advisors, a multi-million dollar Bitcoin hedge fund based in Jersey. Before noticing Bitcoin, Masters worked for Shell Oil Company and engaged in commodity trading for 30 years.

In June 2016, Bitcoin's mining reward reduction was one of the reasons many people predicted that the price would hit new highs. Bobby Lee, CEO of Bitcoin exchange Bitcoin China, also believes that the reward halving event will have a significant impact on the price, and said that the price may rise as much as 8 times from now to the future. Before this summer, the price rose as high as $3,500. "For such an innovative, decentralized digital asset, are we underestimating it? But it will take a while for people to realize this."