Whenever bitcoin moves into a bear market, the victory laps commence.
My personal favorites are those who have been “anti-bitcoin” for years, often academic types that told you when BTC price was sub-$100 that it was a scam. Then they state how they were right at $20,000 bitcoin – the irony is rich.
I’m not writing this for the bitcoin bulls or those who can’t be intellectually honest, but for those who fall in between bull and bear. I’m also not here to argue the fundamentals of bitcoin as a store of value; there are plenty of great articles on the why and how of that. Instead, I’d like to look at bitcoin from an investment standpoint alone and allow the math to reveal whether or not it deserves a long-term allocation for clients.
For starters, a financial advisor always preaches long-term investing. The oracle of Warren Buffett, "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes." The rules seem to change when making points about whether or not to own bitcoin – it’s often measured in quarterly returns instead of years – but how about we look at three- and five-year time horizons? (That’s still too short for Warren, of course, but the numbers only look more favorable for bitcoin the further we go back.)
By looking at these figures while bitcoin is down over 60% from its all-time high (at the time of this writing) it should drive the point home for everyone.
The two-year ROI of bitcoin surpasses the eight-year ROI of the S&P 500, which is telling considering how well the S&P 500 has done over the past decade.
Now, what about risk? An investment that has drawdowns of -93% in 2011, 85% in 2013, -83% in 2017, and 72% YTD cannot be investable. The standard risk metrics like Sharpe or Sortino ratios would show that right? Wrong – let’s dive in. (All data shown is as of 6/20/2022.)
The Sharpe ratio is the measure of risk-adjusted (really volatility-adjusted) returns. It’s a way to measure how much return an investment generated for the risk (volatility) endured over some time horizon. (Higher is better.)
Sortino ratio is a measure very similar to the Sharpe ratio. The big difference is it does not penalize an asset for upward volatility as that volatility is not unfavorable. Whereas Sharpe ratio measures the asset's performance against some benchmark per unit of bidirectional volatility, Sortino measures per unit of downside volatility only. This can provide a more real-world indication of the asset's desirability. (Again, higher is better.)
What do you notice? Even during one of the largest drawdowns in its history – bitcoin is less risky than bonds over the last three and five years. Gold has also been the better diversification tool than bonds when comparing it to correlations to the S&P 500 and has a positive return. Should we not be telling clients not to own bonds?
The upshot: A blend of stocks, bonds and bitcoin has outperformed stocks and bonds. Let’s say, for whatever reason, you couldn’t own spot bitcoin and only had access to the Grayscale Bitcoin Trust (GBTC). The GBTC currently trades at a 35% discount to its net asset value (NAV), has lagged the spot price of bitcoin, and has a 2% management fee attached to it. We will use it as the proxy given the wide availability of its ownership – again, spot would only improve the following figures. (Disclosure: Grayscale is a wholly owned subsidiary of DCG, which is also CoinDesk's parent company.)
So, how about we take a quarterly rebalanced portfolio with 55% allocated to the S&P 500, 35% in U.S. Aggregate Bonds, and 10% in the GBTC, and compare that to the S&P 500 and the ageless 60/40 stocks-to-bonds portfolio.
So what do we see? When looking at the risks of downside only (Sortino ratio) the blend outperforms from a risk perspective. Not to mention on the five-year figure there is a measurable total return outperformance at over 5% annualized – a lower drawdown vs S&P 500. Lastly, risk metrics outperform the 60/40 portfolio. All while seeing two 70%+ corrections along the way.
Bitcoin has loud and often obnoxious supporters, and you might even consider me in that camp. But the rationale for an allocation for bitcoin is undisputed when examining the facts and figures of it as an asset. For too many the view of bitcoin as an investable becomes a false binary: all or nothing. To really examine it, you have to put the emotion around periods like the current downturn aside and ask the most basic investment questions: what is your time horizon?
The U.S. Aggregate Bond Index has provided a 1.34% total return over the past 10 years, and a negative return for YTD, one- and three-year periods. Why aren’t there calls for the removal of bonds as an investable asset class? Rates are low and inflation is high, leading to corporate and sovereign debt approaching or hitting all-time highs. Bonds have been a staple for years as a source of diversified returns, but have been on the back of falling interest rates since the early 1980s.
Yet with Bitcoin, the treatment is usually that of a YOLO meme stock. The stark contrast seems to stem from a belief that bitcoin is not real or that it will not survive, and not enough advisors have spent time educating themselves on what bitcoin is and does as a network and an asset. The truth is the same fears used around volatility for bitcoin could be used to prevent investors from owning stocks. Yet advisors often remind clients of the "why" for stock ownership and that being a long-term investor will benefit them.
Financial advisors that want the best outcome for clients would be wise to review the data and run the numbers on bitcoin. There are facts and then there are feelings and the facts point to bitcoin being a significant contributor to returns for any true long-term investor.
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