Registered investment advisors have long leaned on the 60% equities/40% fixed income portfolio structure. While it’s not perfect, it has served clients well, broadly speaking. But if an entire portfolio is allocated to just two asset classes, there’s no room for alternative assets. Alts can provide critical elements of diversification and upside potential. Those assets can include bitcoin ETFs.
Bitcoin is now easier to include in basic portfolios thanks to the recent debuts of spot bitcoin exchange traded funds, including the Invesco Galaxy Bitcoin ETF (BTCO).
Funds such as BTCO further democratize access to the largest cryptocurrency. And they open the door to broader adoption among advisors. They could potentially be implemented into 60/40 portfolios.
Risk Tolerance Is Key for Your Portfolio
As advisors know, one of the key purposes of a 60/40 portfolio is for the fixed income sleeve to defray some of the risk associated with equities. That actually accounts for far more than 60% of the portfolio’s risk.
By adding BTCO or a comparable ETF to these portfolios, it’s reasonable to surmise volatility will increase. As such, spot bitcoin ETFs are not suitable for all clients. For those wanting exposure to digital currencies, getting the size right is critical.
“A small dose of 1% or 2% bitcoin doesn’t have a big impact on your portfolio. At these levels, bitcoin contributes roughly 3% and 7% of total risk, respectively, and results in a minimal change to overall volatility,” noted Morningstar analyst Stephen Margaria.
The risk proposition is considerably amplified when a portfolio’s exposure to bitcoin reaches or exceeds 5%. At that level, the digital currency accounts for an outsized percentage of the portfolio’s overall risk profile.
“While a little bitcoin can go a long way, it is at greater exposures where investors will see the largest shifts in the total risk toward bitcoin. At 5%, the bitcoin allocation contributes over 20% of the portfolio’s total risk and produces a volatility that’s roughly 16% over the 60/40 portfolio. A 10% allocation increases volatility by 41%,” added Margaria.
That’s not a knock on bitcoin, but it is indicative of the cryptocurrency’s volatile history. In other words, ETFs such as BTCO could be useful additions to 60/40 portfolios, but mainly for risk-tolerant long-term investors who can ride out the digital currency’s bumpy history.
“Altogether, bitcoin’s volatility can have an outsize impact on a standard 60/40 portfolio. With bitcoin’s newfound accessibility through ETFs, many investors will look at its sizable returns and be keen to add it to their portfolios. But before doing this, they should consider the cryptocurrency’s significant volatility and how even a little bit can dramatically change a portfolio’s risk profile,” concluded Margaria.
For more news, information, and analysis, visit the Crypto Channel.