Does crypto allocation enhance your portfolio?

Cryptocurrencies have seen an exponential increase in interest ever since the Reserve Bank of India (RBI) ban was lifted in March 2020, with Indian exchanges clocking impressive user additions and a sustained surge in daily trading volumes. For instance, WazirX witnessed a record trading volume of over $43 billion in 2021 – the highest in India – accounting for 1,735% growth over 2020.

Crypto is a new breed of asset class that has delivered higher returns but with equally higher risk. They are growing in adoption worldwide and some experts believe that they merit inclusion in an investment portfolio.

“It is like what Warren Buffett says, “don’t put all your eggs in one basket”. You need to have all the different kinds of asset classes in your portfolio; some commodity, crude oil, currency, stocks, bonds and crypto as well. If you want to maintain a balanced portfolio, you need to have all of them,” said Sidharth Sogani, founder and chief executive officer of CREBACO Global, a research company focused on blockchain and cryptocurrencies. Sogani suggests 4-5% allocation in crypto assets can limit the downside risk and provide a boost to the overall portfolio.

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But how much does crypto boost a portfolio? We compared a standard investment portfolio of equity and debt in the 60:40 ratio to a portfolio comprising equity, debt and bitcoin in the ratio of 55:35:10 over the last five years.

The data showed that ₹1,00,000 invested at the start of calendar year 2021 in a standard format ( ₹60,000 equity and ₹40,000 debt) would have fetched investors ₹1,13,600. However, adding 10% to the portfolio mix would have boosted returns at the end of the year to ₹1,18,725. Further, the backtesting of this model showed that in 2017, a standard portfolio of ₹1,00,000 would have increased to ₹1,17,600, while the bitcoin portfolio could have fetched ₹2,54,800. However, it has not been smooth sailing for crypto assets, as bitcoin had slumped over 70% during 2018, which could have taken a crypto portfolio (equity 55%, debt 35% and bitcoin 10%) into the negative. Financial advisers do have a word of caution here. According to them, people who are in the process of setting their overall investment portfolio, shouldn’t venture into crypto assets.

“We first suggest people to take care of their core portfolio, and on top of that, if they have some investible surplus after taking care of all their financial objectives, they can then try to diversify, maybe, 2-3% of the portfolio into crypto, if the clients insist. However, investors should consider that a high-risk, high-return kind of investment,” said Harshad Chetanwala, a Sebi-registered investment adviser and co-founder of MyWealthGrowth.

A core portfolio is a mainstay of an investor’s portfolio in which they don’t typically take higher risk. While crypto assets, especially bitcoin, are touted as a new asset class that provides some diversification from traditional asset classes, there have been questions raised in the recent past.

According to a recent IMF report, before the pandemic, crypto assets such as bitcoin and ether showed little correlation with major stock indices. “They were thought to help diversify risk and act as a hedge against swings in other asset classes. But this changed after the extraordinary central bank crisis responses of early 2020. Crypto prices and the US stocks both surged amid easy global financial conditions and greater investor risk appetite,” monetary policy and capital markets experts from IMF wrote.

For instance, as per IMF, returns on bitcoin did not move in the same direction as the S&P 500, the benchmark stock index for the US, during 2017–19. The correlation coefficient of their daily moves was just 0.01, but that measure jumped to 0.36 for 2020–21 as the assets moved more in lockstep, rising together or falling together.

The stronger correlations suggest that bitcoin has been acting as a risky asset. Its correlation with stocks has turned higher than that between stocks and other assets such as gold, investment-grade bonds, and major currencies, pointing to limited risk diversification benefits.

The stronger association between crypto and equities is also apparent in emerging market economies, several of which have led the way in crypto-asset adoption. For example, as per the IMF, the correlation between returns on the MSCI emerging markets index and bitcoin was 0.34 in 2020–21, a 17-fold increase from the preceding years.

However, Sogani counters this by saying that geopolitical situations don’t fundamentally impact the price of bitcoin. “Of course, whenever there is a panic like the covid pandemic or the global markets crashing, there will be some price impact, but this is a different segment that recovers faster than traditional assets,” he said.

As per the expert, the bitcoin price may trade sideways in the first quarter. “Till April, I’m seeing like a $50,000-$55,000 range and once we break on the upper side and everything goes as per the technical analysis, we may still see $85-90,000 in this year. But it depends on when bitcoin is going to get the momentum,” said Sogani.

While investors may increasingly get attracted by meteorological returns given by some of the digital assets, financial advisors have a word of caution.

“I still believe that crypto assets should not be added to a portfolio. it is only meant for those investors who have already have their finance and investment sorted and who have some additional surplus on which they can take some additional bet,” said Chetanwala.