Crypto assets hardly correlate with traditional asset classes and make portfolios crisis-proof, says William Ramstein . In this article, Market Research Blog writer stresses the importance of portfolio diversification to reduce risk and get higher ROI.
The crypto markets are currently in bull mode. Investors holding positions in Bitcoin, Ethereum or other crypto assets can look forward to triple-digit returns this year. In such market phases, many investors concentrate mostly on the pure increase in value: How much have the prices increased? Will they keep increasing? Which crypto assets have the greatest price potential?
These questions are understandable, because every investor is happy about rising prices. When hunting for returns, however, investors often lose sight of the fact that there are at least two aspects to every investment: return and risk. The current price development shows that the return on crypto assets is right. But: what about the risk?
Crypto assets have a low correlation in the portfolio
First a little digression. Investment experts agree that risk should not be viewed in isolation when it comes to an investment property, but rather only in conjunction with the rest of the portfolio. The magic word here is diversification. We are looking for investments that correlate as little as possible with the rest of the portfolio.
In other words, the price of asset A should develop as independently as possible from the price of asset B. This reduces the volatility – and thus the risk – of the entire portfolio.
This is where it gets particularly exciting, because when it comes to diversification, crypto assets show their great strengths. They are among the few asset classes that have been shown to have a low correlation to all other major asset classes such as stocks, bonds and real estate. That means: Although the volatility of crypto assets is high in absolute terms, an addition does not automatically lead to a higher risk in the portfolio.
Specifically, this can also be expressed in numbers: the correlation between Bitcoin and the stock market, represented by the MSCI World Index, is currently around 0.2. To classify: A value of 0 means that there is no correlation. The diversification effect is then very high; a value of 1, on the other hand, stands for a complete correlation, there is no diversification effect.
Typically, the correlation between different asset classes is between 0.5 and 0.9. Crypto assets are therefore extremely well suited to bringing the coveted diversification effect into the portfolio.
With all the advantages, however, there is one small restriction: As with other forms of investment, the diversification effect with cryptos is most pronounced over longer periods of time. In extreme market situations, the prices of different investments often move in parallel for a short time.
This effect could be observed in March 2020, when panic broke out in the markets due to the corona pandemic and the prices of all forms of investment – even gold and government bonds – briefly collapsed. However, the prices of crypto assets recovered comparatively quickly and have now completely decoupled from the development of the stock markets.
So the diversification effect is intact if you look at a period of a few months. Finally, it is worth taking a look into the future. Will the correlation stay low? There are some arguments in favor of this, because the value of crypto assets is subject to fundamentally different influencing factors than the value of stocks, for example.
Technical development, use and acceptance are advancing, unaffected by what otherwise happens in the economy. In addition, crypto assets – especially Bitcoin – are now actively used as so-called “hedging assets”. Investors consciously buy Bitcoin in order to hedge against an expected decline in the value of fiat currencies such as the US dollar and the forms of investment listed in US dollars.
This creates a self-reinforcing effect: Signs of weaknesses in other forms of investment lead to increased demand for crypto assets, the price of which increases as a result. As a result, the price of crypto assets is decoupled from the traditional capital markets – investors benefit from the diversification effect.
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