It is hard to believe that before 2000, most traditional institutional investment portfolios were not allocated to commodities. Balanced portfolios of stocks (60%) and bonds (40%) were the norm. Alternatives were nowhere to be found and often avoided.
Although Nobel laureate Harry Markowitz said in 1952 that “diversification is the only free meal when it comes to investing,” it was only over the millennia that portfolios really began to diversify more towards alternatives. The argument for diversification was based on simple math: Achieving higher risk-adjusted returns through diversification to include alternatives such as commodities and managed futures.
We have already seen this movie
Chris Tyrer, head of Fidelity Digital Assets Europe, says in a new paper that many of the barriers financial institutions face in allocating bitcoin and other digital assets are similar to those faced in accessing commodities markets early on. millennia – we’ve seen it movie before.
Tyrer says: “The stock market’s underperformance (1Q20-4Q02) created an environment in which investors were open to exploring other sources of return. Indeed, this propensity has persisted and increased over time, as evidenced by alternative investment allocations, which, according to estimates published by the CAIA Association, accounted for 6% of global investment markets in 2003. and up to 12% in 2018. ”
It is now recognized that commodities are a separate asset class for traditional investment purposes, and many advisable portfolios have some exposure to commodities as an asset class. Fidelity’s 2021 Institutional Investor Digital Asset Study of more than 1,000 institutions found that 23% of respondents believe digital assets belong to an independent asset class.
Tyrer highlights the similarities in developing emerging commodities markets with current maturing digital asset markets and highlights several common characteristics, including a developing product suite, market access, improved regulatory environment and infrastructure. market in transformation. From the launch of bitcoin ETFs approved by regulators, to the development of institutional custody of digital assets, to the development of digital asset futures, the ‘sequel’ has now matured and is ready to be made available to institutions, such as The commodity markets bear witness to this.
The exceptional performance of Bitcoin over 10 years
The most compelling case, however, is the exceptional performance of the asset class. Bitcoin’s 10-year performance to the end of 2020 significantly outperformed all other asset classes with just two years of decline, in one of the years the S&P was also down. It is this performance, which is largely uncorrelated to other asset classes, that attracts investors at all levels. The Fidelity study found that 52% of (institutional) investors surveyed in Asia, Europe and the United States have an allocation to digital assets.
Tyrer adds: “Recent global monetary policy, and increasingly fiscal policy, has created a positive macroeconomic backdrop for future bitcoin investment allocations and many investors remain concerned about the rate of expansion of the balance sheet of the central bank, the size of the current budget deficits in many countries. developed economies, and the resulting inflation potential.
“Bitcoin is viewed by many as an asset that will have a leveraged return profile in an inflationary environment and therefore view it as a portfolio hedge against that result.”
Investors like Greg Foss, the career high yield bond trader turned bitcoin bull, agree. He also pointed out that we went through a similar period of adoption by the high yield debt market in the 1980s. Michael Milken, the architect of the junk bond, was an outcast in the eyes of institutional investors from Wall Street to in its early days, until its approach to risk-adjusted (relative to equities) junk bond yields was adopted.
Foss co-created the Fulcrum Index, an index that “calculates the cumulative value of Credit Default Swap (CDS) insurance on a basket of G-20 sovereign countries multiplied by their respective funded and unfunded obligations.” According to the former bond trader, the index could form the basis for a current valuation of bitcoin, which he calls “the best asymmetric trade I’ve seen in 32 years.”
Tyrer points to the research of his colleague, Director of Global Macro at Fidelity Investments, Jurrien Timmer, and the analysis of the S-curve correlation between mobile phone subscriptions and bitcoin addresses, observing “it seems that the bitcoin’s growth curve is still in its early stages. and could remain so for several years.
So, the bullish case of bitcoin: the price is at the intersection of supply and demand, and demand increases exponentially as supply (by BTC stock-flow) approaches its limit. Bitcoin can act as a store of value due to its scarcity, but it’s also an integral part of a technological revolution (blockchain encryption) with potentially explosive demand growth, ”Timmer wrote.
A compelling macro backdrop
While there are many similarities between today’s digital asset markets and the commodities markets of the early 2000s, Tyrer points to significant advancements in catalysts for institutional participation and, what is also Importantly than for commodities in the early 2000s, these developments are occurring at a time when the investment narrative and macroeconomic context is compelling.
The growth of the crypto-asset markets, now at $ 2 trillion, has been largely driven by the retail market and private capital since the 2008 financial crisis. Governments and the traditional financial services industry have failed. really played an important role to this day. It has been one of the historically most interesting and socially beneficial incubators for the development of an asset class ever seen. Amid low interest rates, historic public and personal debt levels, and rising inflation, digital assets have so far proven their worth.
In commodities, the conditions of the early 2000s resulted in a significant volume of institutional capital entering the asset class in the years immediately following, seeking diversification of asset classes through risk-adjusted returns. higher. It remains to be seen whether bitcoin and other digital assets will attract similar volumes, but it is most certainly possible to justify diversifying asset classes through higher risk-adjusted returns, and the current direction of travel has certainly confirmed the trend at which institutional investors have arrived.