Why every person, company, asset manager and government will eventually own Bitcoin: Part 3— Asset Managers
My last two posts covered why I believe we will see mass adoption of Bitcoin by individuals and corporations in the coming decades. You can read those posts here and here. In part three of this series, I’m going to cover why asset managers are already adopting Bitcoin and why this trend will only continue to accelerate in coming years.
2020 and 2021 will be remembered as the time when Bitcoin became widely adopted by institutional investors. Whereas the last bull run in 2017 was primarily fueled by retail investors, the recent increase in price has been driven much more by asset managers. Investors all over the world increasingly view Bitcoin as a reliable store of value and a viable macro hedge rather than a speculative asset. The list of notable institutional investors that have publicly proclaimed their belief in Bitcoin is growing by the day.
- Paul Tudor Jones called Bitcoin “the fastest horse” and invested 2% of his assets in Bitcoin.
- Stanley Drunkenmiller invested in Bitcoin, saying if “the gold bet works, the Bitcoin bet will probably work better.”
- Bill Miller said that Bitcoin’s supply demand economics is so attractive that he thinks “every major bank, every major investment bank, every major high net worth firm is gonna eventually have some exposure to Bitcoin.”
- Ray Dalio said that Bitcoin has “established itself” over the last ten years.
- Larry Fink said “Bitcoin could evolve into a global market asset” and granted at least two BlackRock funds the ability to invest in Bitcoin.
- Rick Rieder of BlackRock believes Bitcoin “will take the place of gold.”
- Scott Minerd has directed Guggenheim’s Macro Fund to invest up to 10% in Bitcoin.
- Christopher Wood reallocated 5% Jefferies Group’s position in gold to Bitcoin.
- Mark Yusko believes Bitcoin will exceed $100k in 2021 and that “everyone should have at least 1–5% of their portfolio in Bitcoin.”
- Dan Tapiero said he thinks in time, “every institutional investor and high net worth individual will allocate 5–15% of their portfolio to Bitcoin.”
- Eric Rivers believes the “flows into Bitcoin have only just begun.” One River Asset Management recently purchased $600 million in Bitcoin and Ether and intends to upsize to $1 billion in early 2021.
- Ruffer Investment Co invested $744 million (2.7% of assets) in Bitcoin.
- Stone Ridge CEO stated that cash is a liability and no longer an asset at the MicroStrategy World 2021 Conference as well as invested $162 million in Bitcoin as part of its treasury reserve strategy.
- The endowments for Yale, Harvard, Stanford, MIT, Brown, University of Michigan, Univeristy of North Carolina and more have invested in both crypto funds and directly into Bitcoin.
And all of this pales in comparison to Grayscale’s Bitcoin Trust which, despite charging a 15–30% premium to the spot price of Bitcoin, grew its AUM from $2 billion to $20 billion in 2020. This huge growth illustrates just how much demand there is from investors to gain exposure to Bitcoin in their stock market and IRA accounts even if it means paying a healthy premium. And this isn’t the only indication of demand. According to Fidelity, the interest in Bitcoin surged among institutional investors in 2020. JP Morgan highlighted evidence of institutional investors moving out of gold ETFs and into Bitcoin.
The bottom line is Family Offices, RIAs, Hedge Funds, Fund of Funds, Endowments, Pension Funds, Sovereign Wealth Funds and Investment Banks have all started investing in Bitcoin and this trend will only continue to accelerate in the coming years. Let’s dig into why all these capital allocators are jumping into Bitcoin.
Performance
Bitcoin has been the best performing asset over the last 10 years. Bitcoin has grown 216% annually on average for the last decade. Even allocating as little as 1–5% of a portfolio to Bitcoin would have had significantly improved that portfolio’s performance during this time. In fact, any investor that bought Bitcoin and held for at least three years, saw that investment increase in value regardless of what price they bought in at.
While Bitcoin has generated tremendous returns to date, there is still a lot of potential upside to investing today. With interest rates so low and valuations in other asset classes so frothy, a lot of smart investors are realizing that Bitcoin offers an asymmetric return profile that few other assets currently possess. In other words, while there exists the possibility that the price of Bitcoin could go down, the upside is orders of magnitude greater.
- Tom Fitzpatrick and Citibank now believe Bitcoin will be worth as much as $318k in 2021.
- Scott Minerd of Guggenheim believes the fundamental value of “Bitcoin is at least $400k”
- Cathie Wood of ARK Investments believes Bitcoin will be worth “somewhere in the $400k — $500k range”
- JP Morgan recently released a report stating that “if Bitcoin stays the course and draws more investors, it could reach a price level of $650k.”
What other publicly traded, liquid asset has the possibility of seeing a 3–10x return this year and upwards of a 30x return over the next 5 years? Even if there is only a small chance these predictions are right, the risk-return profile is worth allocating a small portion of a portfolio especially in a world where interest rates globally are near, at, or below zero. The opportunity cost of not allocating to Bitcoin is too high. As a result, any investor looking for yield will eventually end up owning Bitcoin if they do not already.
“Most people have an overallocation to bonds relative to where they should be. It can’t go all into equities and people are thinking about inflation to begin with. It will be very natural for Bitcoin to absorb some of the money flowing out of bonds.”
- Cathie Wood, ARK Invest
Risk-Return Profile & The Efficient Frontier
What is even more interesting about Bitcoin beyond just its historical performance and potential upside, is that its nearly uncorrelated to any other asset class. Historical data indicates that Bitcoin has a near zero correlation with all other classes and its correlation is substantially lower than nearly any other asset class pair. Even Fidelity has stated “there is almost no relationship between the returns of Bitcoin and other assets.”
This low correlation means that Bitcoin can add diversification to any traditional portfolio. Any capital allocator’s eyes should light up when reading that sentence. The reason is, as Modern Portfolio Theory explains, adding an asset that is non correlated to a portfolio increases the expected return for that portfolio and at the same time decreases the risk.
That’s right, adding Bitcoin increases returns and decreases the overall risk of a portfolio. In other words, adding Bitcoin to a portfolio shifts the Efficient Frontier of that portfolio upward.
To demonstrate how this works, Adam Pokornicky of Digital Asset Investment Management used historical data to analyze the benefits of adding Bitcoin to a real-world portfolio. His work shows how Bitcoin offers considerable diversification benefits and how investors can build portfolios with higher risk-adjusted returns. Reallocating 5% of a portfolio to Bitcoin would have yielded a 225% annual return improvement while at the same time more than doubling the Sharpe Ratio of the portfolio.
And Adam isn’t the only one to come to these same conclusions.
- Fidelity showed that as you increase a portfolio’s allocation to Bitcoin from 0% to 3%, both the returns and Sharpe Ratio increase substantially.
- Alex Woodard of Arca concluded that “the optimal portfolio calls for an allocation of 14.21% to Bitcoin and the rest to 60/40 portfolio.”
- According to a study done by Bitwise, “adding a 2.5% bitcoin allocation with quarterly rebalancing would have improved the cumulative return of the portfolio from 26.2% to 44.9%. Importantly, this result would have been achieved without significantly changing either the portfolio’s volatility (10.1% with bitcoin, up from 9.9% without) or its maximum drawdowns (21.8% with bitcoin, up from 21.1% without). The portfolio’s Sharpe ratio, which measures excess returns per unit of risk, would have improved by a whopping 71.4%.
- Grayscale released a report that concluded adding a 5% allocation to Bitcoin improved returns for a global portfolio from 41.3% to 89.8% while at the same time improving the Sharpe Ratio from 0.68 to 1.27.
- Rao Paul at RealVision concluded adding 5% to Bitcoin not only significantly improved performance, but the “overall portfolio reduced its risk concentration to equities and become more balanced.”
The bottom line is Bitcoin increases the returns, diversification and Sharpe Ratio of any portfolio.
Hedge Against Fiat Debasement
Bitcoin also acts as an ideal hedge to current macro-economic conditions. So much so that we are at a point where it would be irresponsible for any capital allocator who has any concerns about future consequences to today’s action by governments not to allocate at least some percentage of their portfolio to Bitcoin.
Since September 2019, the Federal Reserve has pumped over $9 trillion into the economy and in 2020 alone, the U.S. has created 22% of all the US dollars issued since the birth of the nation. This does not appear to be stopping anytime soon as the new administration has announced plans for an additional $1.9 trillion in new economic stimulus in 2021.
This is not an argument for or against the record level of monetary stimulus, but we do need to acknowledge that it is occurring. Regardless of whether it is the right decision today (I will leave that for others to debate), there are likely to be consequences in the future for doing so. Those consequences may include increased inflation, hyperinflation and potentially, in a worst-case scenario, even the collapse of the US dollar.
If this sounds like hyperbole, there are numerous real world historical examples to point to. Moving away from the gold standard 50 years ago gave governments full control over the supply of fiat currencies. One of the drawbacks to doing so is that governments are more incentivized to support policies that stimulate economic growth even at the expense of the stability of the currency. According to the work of economist Steven Hanke, more than 50 hyperinflation episodes of fiat monetary systems have taken place around the world in the past century. While the US has yet to experience hyperinflation, if you think being the world’s largest economy or the world’s reserve currency protects the dollar from being devalued, think again. According to The Fed’s Consumer Price Index, $1 in 1913 (the year The Federal Reserve was established) would buy you roughly what would require $26.15 in 2020. That is a cumulative loss of a little over 96% in purchasing power from the most dependable fiat currency in the world during that time span. And that was prior to the $10+ trillion of new money printed in response to COVID.
As Anthony Pompliano argues, the challenges facing fiat currencies today are not technological in nature, but rather a monetary policy problem. This is where Bitcoin provides an attractive alternative.
Bitcoin has a capped supply of 21 million. Once mined, there will never be more Bitcoin. This absolute scarcity is a key driver of value for Bitcoin and in stark contrast to the “unlimited” amount of fiat currency that can be produced.
Bitcoin’s monetary policy goes beyond just a capped supply. Unlike fiat currencies, gold and other commodities, Bitcoin’s supply issuance is transparent, predictable and most importantly, inelastic. On average, a new block (and thus new Bitcoin) is mined every ten minutes. The amount of Bitcoin mined per block gets cut in half every four years in what is known as the “Halving.” The last Halving occurred in May 2020 so just as the federal government was increasing the amount of money printing to record levels, the supply of newly issued Bitcoin was cut in half.
Furthermore, Bitcoin’s network difficulty is dynamic and adjusts in real time. This means that as more computing power is added or subtracted from the network to mine Bitcoin, the difficulty required to successfully mine a block adjusts so that on average, a block is mined every 10 minutes. In other words, regardless of the price of Bitcoin, the supply issuance stays constant. Unlike gold and other commodities where more gets mined if there is a dramatic increase in price, Bitcoin’s supply issuance is inelastic.
All of these characteristics give Bitcoin a monetary policy that is the exact opposite of fiat currencies. Add in the fact that Bitcoin, unlike real estate or other store of value assets, trades 24/7 and is thus highly liquid, it’s easy to understand why Bitcoin is being considered an ideal hedge to current macro-economic conditions.
Conclusion
Due to Bitcoin’s historical performance, the potential upside remaining, the fact that adding Bitcoin to a portfolio increases a portfolio’s efficient frontier, and that it’s the best available hedge against current macro-economic conditions, institutional investors have begun flocking to Bitcoin in droves. I would argue that any institutional capital allocator not adding Bitcoin to their portfolio is not fulfilling their fiduciary responsibilities. Those that haven’t added it yet will do so in the near future or will face scrutiny from their investor base. In time, every asset manager will own or have exposure to Bitcoin as part of their portfolio.
