Integrating Bitcoin into passive multi-asset portfolios
As the landscape of financial markets rapidly evolves, investors in passive multi-asset portfolios like the Magwitch USD Growth ETF are increasingly considering the role of cryptocurrencies. Integrating Bitcoin presents an intriguing opportunity to enhance both returns and diversification, although its inherent volatility demands careful consideration. In this edition of Magwitch Insights, we examine what adding Bitcoin means for portfolio strategy, including its correlation with traditional assets, its effect on returns and drawdowns, and how rebalancing can help manage risk.
Diversification
Traditional portfolio diversification often relies on assets with low or negative correlations to cushion against market downturns. Historically, bonds have served this purpose against equities. However, as financial markets evolve, new assets like Bitcoin are emerging as potential diversifiers. The correlation between Bitcoin and traditional assets has been a subject of intense scrutiny.
As seen in the “Rolling 3-Year Correlations of Bitcoin, Stocks, and Bonds” chart, Bitcoin’s correlation with both stocks (represented by the S&P 500) and bonds (represented by the Bloomberg U.S. Aggregate Bond Index) has fluctuated in the past. In the past 3 years however, correlations are seen to be increasing and therefore lowering Bitcoin’s diversification benefits.
Returns & Risk
Bitcoin performance was muted in the early years as it was a nascent market for investors with lower liquidity and difficulty of access, but it has still delivered annualised returns of 178% over its longer history (Aug. 1, 2010–March 31, 2024). Since 2018, when bitcoin futures were launched and institutional interest grew, annualised returns have been in the region of 29.6%.
Bitcoin consistently appears at the top (highest returns) or near the bottom (lowest returns) of the annual asset class performance rankings.
This highlights its unparalleled volatility compared to other asset classes. Because different asset classes perform well in different market conditions, holding a diversified portfolio (which includes various asset classes like equities, bonds, real estate, commodities, and potentially Bitcoin) can help smooth out overall portfolio returns and reduce reliance on any single asset’s performance. Bitcoin, while offering immense return potential, demands a high tolerance for risk and is best used as a small, tactical allocation within a broader, well-diversified portfolio due to its extreme volatility.
Bitcoin in Magwitch USD Growth ETF Portfolio
Our Magwitch USD Growth portfolio has a strategic asset allocation of 75% to global equities and 25% to US Dollar denominated fixed income. In our analysis of the impact of adding Bitcoin to a portfolio we have incrementally added Bitcoin to this portfolio at 1% allocation, 3%, 5% & 10%.
The above asset allocation pie charts provide a visual representation of the hypothetical portfolios and their increasing exposure to Bitcoin. The statistical table below shows the impacts to returns and volatility over the past 10 years in US Dollars.
In analysing the table, the one that stands out for us is the Magwitch Growth + 3% Bitcoin. This portfolio appears to be the most appealing for a broad range of investors seeking a balance between risk and return. It offers a notable increase in return (11.36% vs. 8.51%) with only a modest increase in volatility (13.20 vs. 11.68). The Magwitch Growth + 3% Bitcoin allocation portfolio would have over the past decade, provided investors with a higher return than a 100% equity portfolio represented by the MSCI World NR USD Index, with a lower volatility. Essentially the investor has benefited from the excess returns of Bitcoin and from the reduced volatility of the bond component.
The maximum drawdown is slightly higher (-24.95% vs -22.56%), but the improved returns and risk-adjusted returns might justify this for many. It provides a substantial uplift in returns and, more importantly, a superior risk-adjusted return (as indicated by the Sharpe Ratio) compared to the base portfolio, without taking on an excessively high level of volatility or drawdown that the 10% Bitcoin portfolio introduces. It seems to strike an optimal balance between enhancing returns and managing the increased risk associated with Bitcoin.
Despite Bitcoin’s reputation for high standalone volatility, its integration at low portfolio allocations yielded surprisingly modest increases in overall portfolio volatility. For instance, a 3% Bitcoin allocation resulted in a 152-basis point rise in volatility, representing a potentially worthy trade-off when considering the associated return enhancement. These empirical findings challenge the conventional perception that Bitcoin significantly compromises portfolio risk metrics at modest allocation levels, instead suggesting a compelling asymmetry: a minor increase in risk potentially leading to outsized return benefits.
Rebalancing
Because Bitcoin is highly volatile, it’s essential to rebalance your portfolio regularly. If you don’t, your Bitcoin allocation can quickly stray far from your target – especially during strong market rallies. A relevant example is the hypothetical 1% Bitcoin Portfolio, where an annual rebalancing schedule would have allowed its Bitcoin allocation to inflate to 14.4% by late 2017. Sticking to a disciplined rebalancing strategy helps lock in gains when prices rise and reinvest wisely when they fall, keeping risk in check.
Conclusion
Bitcoin is becoming a more common investment, but it’s not one you can just leave alone. Investors should weigh its potential upside against real risks and only dedicate a small part of their portfolio to it. While Bitcoin’s long-term role is still developing, it has shown it can boost returns and add diversification when used strategically. Still, due to its volatility, it requires careful monitoring, thoughtful allocation, and regular rebalancing.
Magwitch Offshore is a leading provider of Global Balanced ETF portfolios with products in all major currencies. Magwitch utilises an advisor distribution model and their portfolios are available through offshore endowment structures provided by some of the larger Insurers.