Investors should allocate about 1% to 2% of their portfolio into Bitcoin, according to BlackRock Investment Institute (BII), which uses a risk budgeting approach by sizing the allocation based on how much it would contribute to total portfolio risk.
“Bitcoin cannot be compared to traditional assets,” says BII’s analysts. However, from a portfolio construction perspective, the “Magnificent 7” group of mega cap technology stocks is a useful starting point in helping to think about Bitcoin allocation, they say.
These “Mag 7” stocks represent a single portfolio holdings that account for a comparatively large share of portfolio risk as with Bitcoin.
In a traditional portfolio mix of 60% stocks and 40% bonds, these seven stocks, if held at their current weights in the MSCI World, each account for 4% of the overall portfolio risk on average, the analysts note. As a result, that is about the same share a 1%-2% exposure to Bitcoin would represent.
“We think that’s a reasonable range for a bitcoin exposure. Why not more? Going beyond that would sharply increase bitcoin’s share of the overall portfolio risk,” BII says. “A bitcoin allocation would have the advantage of providing a diverse source of risk, while an overweight to the magnificent 7 would add to existing risk and to portfolio concentration.”
BII says that it sees a case for investors with suitable governance and risk tolerance to include Bitcoin in a multi-asset portfolio. However, investors need to think differently about Bitcoin’s expected returns, they caution: it has no underlying cash flows for estimating future returns.
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What matters is the extent of adoption, and the analysts see no intrinsic reasons why Bitcoin should be correlated with major assets over the long term, given its distinct value drivers.
BII analysts say that an investor’s portfolio allocation should not extend beyond 2%, as a larger allocation means that a share of overall portfolio risk rises sharply.
“Bitcoin’s risk contribution can spike during periods of heightened volatility or a stronger positive correlation with equity returns. On top of having higher average volatility over time, Bitcoin has also suffered sharp selloffs. In an extreme case, should there no longer be any prospect of broad bitcoin adoption, the loss could be the entire 1%-2% allocation,” they say.
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However, BII thinks that this is much less likely to happen to a Magnificent 7 stock as these companies generate major cash flow and have tangible underlying assets.
The upshot is that by allocating no more than 2% to Bitcoin, investors would introduce a very different source of return and risk, while managing risk exposure to Bitcoin.
BII thinks that investors who choose to allocate to Bitcoin should regularly review Bitcoin’s changing nature and their allocation.
As the cryptocurrency is becoming more accessible to institutional investors, a wider adoption and trading could reduce its volatility and make its low correlation with equities more stable. Meanwhile, lower volatility would trim Bitcoin’s contribution to portfolio risk and allow investors to up their allocation.
Yet broad adoption could also mean Bitcoin loses the structural catalyst for further sizable price rises. The case for a permanent holding may then be less clear-cut and investors may prefer to use it tactically to hedge against specific risks, similar to gold, they note.
