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Bitcoin's low correlation with traditional markets

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Cryptocurrencies tend to move independently of other assets, making bitcoin a good potential source for portfolio diversification

Why it is Wise to add Bitcoin to an Investment portfolio

The Economist

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编者语：《经济学人》于近期发布文章《Why it is wise to add bitcoin to an investment portfolio》（为什么将比特币添加到投资组合中是明智的）。该文章中提到，比特币与传统市场的低相关性使其成为投资组合多元化的潜在优质来源。这篇文章引述了诺贝尔奖获得者哈里·马科维茨 (Harry Markowitz) 在《金融杂志》(Journal of Finance) 发表论文中的一句话，该论文表达了「重要的不一定是资产本身的风险，而是它对于整个投资组合价值波动性的贡献」这一观点，一定程度上奠定了「现代投资组合理论」的基础。

以下为原文：

「多元化既是可观察的又是明智的，一定要拒绝非多元化的行为准则，不论是做假设，还是把它当作格言警句。」

This quote was taken from a 1952 paper by the economist Harry Markowitz in the Journal of Finance called "Asset Selection: Effective Diversification". The paper helped him win the Nobel Prize in economics in 1990 and laid the foundations for "modern portfolio theory".

Left: Harry Markowitz

In this paper, Harry Markowitz firstly defines investor preference mathematically by applying the two mathematical concepts of mean and variance of portfolio return. It is the first time to apply the principle of marginal analysis to the analysis of asset portfolio. The findings are intended to help families and companies use their money to maximize returns at a given risk.

The theory says that a rational investor should maximise his return relative to the risk (the volatility of returns) they take. Naturally, assets with reliably high returns should feature prominently in a sensible portfolio. But Mr Markowitz excels in uncovering the theory that diversification reduces risk volatility without sacrificing returns. If there is an expression for this financial philosophy, it is that the whole is greater than the sum of its parts.

Investors looking for high returns without volatility may not be attracted to cryptocurrencies like Bitcoin, given their regular crashes and rallies in value. But Mr Markowitz's insight is that what matters to investors is not necessarily the risk of the asset itself, but its contribution to the volatility of the value of the portfolio as a whole - which is mainly a matter of the correlation between all the assets in it. Investors who hold two weakly correlated or uncorrelated assets may have a more immediate feeling that while the value of one asset plunges, the other may barely move.

Given that a sensible investor might hold a portfolio of stocks, bonds, real estate funds in different regions and individual precious metals such as gold, the highest-yielding assets "stocks and real estate" tend to move in the same direction at the same time. The correlation between stocks and bonds is weak (about 0.2-0.3 over the past decade). But bonds are also much lower in terms of returns, and investors can reduce volatility by adding bonds, but doing so also often leads to lower overall returns.

That's where bitcoin's strength lies. Cryptocurrencies can be volatile, but the average return over their short lifetime is also high. Importantly, cryptocurrencies tend to move independently of other assets, and the correlation between bitcoin and all stocks in the world has been between 0.2 and 0.3 since 2018, and even weaker if you move forward longer. Bitcoin also has weak correlations with real estate and bonds, making it an excellent potential source of portfolio diversification.

That may explain bitcoin's appeal to some big investors. Hedge fund manager Paul Tudor Jones has said he aims to hold 5 percent of his portfolio in bitcoin. As part of a highly diversified portfolio, this allocation looks reasonable. In all four of Buttonwood's tests over the past decade, the best portfolios have included 1-5% of bitcoin, not just because of the cryptocurrency's boom, but even when bitcoin was volatile, like when it fell precipitously from January 2018 to December 2019, 1% is a bitcoin portfolio that still shows a better risk-reward ratio.

当然，并非所有关于选择哪些资产的计算都是直截了当的。许多投资者不仅寻求做好投资，还致力于做到环境友好，他们认为比特币并不环保。此外，要选择投资组合，投资者需要收集这些资产预期走势的相关信息。预期回报和未来波动通常通过观察资产过去的表现来衡量。但是对于加密货币，这种方法有明显的缺陷，因为过去的表现并不总能表明未来的回报，更不要说加密货币的历史非常短了。

While Markowitz explains how investors should optimize their asset choices, he writes, "We have not yet considered the first stage: the formation of relevant beliefs." The return on a stock investment is a portion of the company's profits, while the return on a bond investment is a risk-free rate plus credit risk. In the case of Bitcoin, it's not clear what's driving bitcoin's returns, other than speculation, and there's reason to believe that bitcoin may not even generate any returns in the future. Many investors hold strong philosophical beliefs about bitcoin -- that it is either a salvation or a curse, but that neither redemption nor a curse can be 1 per cent of these investors' assets.