Isonex Capital
Besides an overall lack of understanding surrounding the blockchain technology that drives digital currencies such as Bitcoin, a primary concern for traditional institutional and private investors alike when it comes to digital currency investing centers on its relatively high volatility against traditional assets such as stocks and bonds.
As an example, while Bitcoin demonstrated impressive returns of around 7,400% over the past five-year period compared with Vanguard Total World Stock (VT) ETF's respected return of 54%, its daily standard deviation of 4.45% is also significantly higher than VT's 0.8% across the same period - a level generally considered to be too high for most investors' risk-return preference.
With that in mind, the team conducted an intriguing analysis that investigated changes in risk-return characteristics of incorporating only 1% of IX15 tokens into a traditional 60/40 stock (Vanguard Total World Stock ETF) and bond (Vanguard Total Bond Market ETF) portfolio over a five-year period (Aug 2013 through Feb 2019). Note this timeframe includes periods of extreme volatility in both directions within the digital currency market. The results were both exciting and highly unexpected.
Consider the following portfolio combinations where a rebalanced portfolio follows an allocation tolerance rule of 3% in either direction. For example, with a 60% target allocation on stocks, the portfolio will automatically rebalance back to 60% whenever stock allocations exceed 63% on any given trading day due to market appreciation.
A traditional 60/40 stock and bond portfolio (with rebalancing)
| Portfolio | Total Return (5.5 years) | Max Draw Down (5.5 years) | Daily Standard Deviation | Sharpe Ratio |
|---|---|---|---|---|
| Traditional 60/40 | 33.34% | -13.56% | 0.5098% | 2.94% |
This portfolio configuration generated a respectable 33% return over a five-year period. More importantly, return was steady with daily volatility of only 0.5098% and a Sharpe ratio of 2.94%. The fund's max drawdown was at 13.56%, which occurred during the global equity markets pullback in Feb 2016.
A 60/40 stock and bond portfolio with 1% of IX15 (59.4%/39.6%/1% after prorating allocation - <strong>no rebalance</strong>)
| Portfolio | Total Return (5.5 years) | Max Draw Down (5.5 years) | Daily Standard Deviation | Sharpe Ratio |
|---|---|---|---|---|
| 1% IX15 (No Rebalance) | 158.05% | -82.53% | 2.0334% | 2.99% |
This "inconsequential" allocation of IX15 had a dramatic impact where total return of the portfolio shot up to 158% over the same five-year period. On the other hand, there is a spike of equal magnitude in risk measures where maximum drawdown and daily standard deviation both reached an uncomfortable level of -82.53%, and 2.0334%, respectively. More notably, the dramatic rise in the digital currency market caused the original 1% allocation to peak at a whopping 89% of the overall portfolio value. While the Sharpe ratio of 2.99% narrowly edges out the traditional portfolio, significant increases in volatility along with intolerable deviation from the original 1% target allocation render this portfolio combination inappropriate for just about any investor.
A 60/40 stock and bond portfolio with 1% of IX15 (59.4%/39.6%/1% after prorating allocation - <strong>with rebalancing</strong>)
| Portfolio | Total Return (5.5 years) | Max Draw Down (5.5 years) | Daily Standard Deviation | Sharpe Ratio |
|---|---|---|---|---|
| Traditional 60/40 | 33.34% | -13.56% | 0.5098% | 2.94% |
| 1% IX15 | 54.31% | -12.71% | 0.4051% | 4.62% |
This is where the story becomes truly remarkable. With a disciplined rebalancing methodology, incorporating a 1% allocation of IX15 has the surprising combined effect of: 1) enhancing total portfolio return from 37.53% to 54.31%, 2) maintaining broadly the same risk measures, and 3) generating a more favourable Sharpe ratio of 4.62% because of higher returns and reasonable risks. The tolerance-based rebalancing strategy also limited the overweight of IX15 tokens to a peak of only 4.62% from over 89% previously.
Incorporating varying allocation of IX15 has an impact on a portfolio's risk-return profile that may be suitable for investors of differing risk tolerance.
| Portfolio | Total Return (5.5 years) | Max Draw Down (5.5 years) | Daily Standard Deviation | Sharpe Ratio |
|---|---|---|---|---|
| Traditional 60/40 | 33.34% | -13.56% | 0.5098% | 2.94% |
| 1% IX15 | 54.31% | -12.71% | 0.4051% | 4.62% |
| 3% IX15 | 57.38% | -13.08% | 0.4247% | 6.02% |
| 5% IX15 | 86.04% | -12.07% | 0.4662% | 6.96% |
| 10% IX15 | 122.44% | -24.51% | 0.6332% | 7.84% |
While digital currencies such as Bitcoin offer potentially high returns as well as incomparable diversification benefits due to a lack of correlation to the tradition stocks and bonds market, they also carry with it significantly higher volatility not tolerable by the broader investment community. Notwithstanding the above, this analysis shows that with an individually optimized IX15 tokens allocation, investors can still reap significant rewards offered by the digital currency market in the form of higher risk-adjusted return, providing investors follow a disciplined rebalancing strategy to ensure that allocations stay in line with target asset weights.
