Key Alternative Investment for Institutions
Fidelity has recently come out with the Bitcoin Investment Thesis report that outlines the potential role of Bitcoin in the institutional investment portfolio. This report should encourage more institutional adoption and comes at the heels of Square and Micro Strategy announcing their significant corporate positions in Bitcoin. The crux of the Fidelity Digital Assets research team’s thesis focuses on Bitcoin as an uncorrelated asset that could enhance the risk & return profile of investment portfolios. Many institutional investors rely on modern portfolio theory that is based on the idea that markets are generally efficient and that each asset in the entire investment universe has a unique expected return and risk profile, but that higher expected returns necessarily come with higher risk. Therefore, the goal in modern portfolio theory is not necessarily to focus on outperformance that necessarily comes with added risk, but to create a portfolio based on an optimal return to risk ratio based on the risk tolerance and objectives of a portfolio. One way to improve the return & risk ratio is to add uncorrelated assets to the portfolio and use mathematical tools to optimize their portfolio’s expected risk/reward performance. Hence institutional investors are always seeking new uncorrelated alternative assets to add to their portfolio. What assets are considered alternative? Fidelity states: “the CFA Research Foundation broadly divides alternatives into hedge funds, private equity (venture capital, leveraged buyouts, risky debt), real assets (real estate, infrastructure, commodities, natural resources, intangible assets), and structured products.”
According to Fidelity, alternative investments have grown from a $4.8 trillion category in 2003 to $13.4 trillion at the end of 2018. The $47 trillion pension funds averaged an incredible 23% in alternatives compared to just 6% in 1999. Some university endowments had as high as 43% allocation to alternatives. With the economic uncertainty of the pandemic and quantitative easing, Fidelity found 80-90% of investors plan to maintain or increase their current and long term investments in alternatives. Bitcoin could be seen as a way to increase diversification and enhance returns as non-yielding assets become a more favorable option compared to bonds that often have a negative real yield. Bitcoin is also uncorrelated to the other major asset classes of stocks, bonds, real estate and gold (Bitcoin’s average correlation among major assets is .11).
Fidelity notes that: 1) Bitcoin is not as dependent on typical economic factors of production like other asset classes 2) the various evolving narratives about what it is may eventually converge to a single thesis 3) Bitcoin has recently been more correlated with gold 4) there has been an increased overlap to traditional markets as institutional trading platforms have increased 5) Bitcoin is primarily still a retail driven phenomena with wallets with less than 1 or 10 Bitcoin have continually increased year by year.
Fidelity also compares Bitcoin to frontier emerging markets that have grown to $5 trillion, or 11% of the $43 trillion global equity market in the last 30 years. Fidelity estimates that Bitcoin supply could have a $1.3 trillion value if it captures 10% of the alternative investment market. As of 2018, bonds amounted to a $53 trillion market and at zero or negative yields just 1% of investment moving away from bonds into Bitcoin would increase Bitcoin’s market cap by $500 billion. Fidelity also mentions additional benefits of Bitcoin to institutions including: 24/7 liquidity, low fees, accessibility. Fidelity’s analysis of hypothetical portfolios with up to 3% Bitcoin exposure in the last 5 years showed that any Bitcoin exposure increased Sharpe ratios and decreased the maximum drawdowns in a portfolio. Fidelity rightly points out that Bitcoin is well positioned to be a viable option compared to overvalued equities and low-yielding bonds and ends their report with the following statement:
“Bitcoin is a unique investable asset with compelling differences relative to traditional asset classes as well as conventional alternative investments that could make it a beneficial addition to a portfolio.”