Bitcoin is often touted as a ‘volatile’ type of currency, but for Jim Kyung-Soo Liew, a finance professor at John Hopkins’ Carey Business School, it could actually make an interesting investment for pension funds. ‘Isn’t cryptocurrency inherently a risky bet?’ you may wonder. Kyung-Soo answers in the negative, noting that Bitcoin “appears surprisingly interesting from a diversification perspective because the return generating process shows to be unrelated to other investment returns.” The risk-return profile of Bitcoin can also prove interesting to institutional investors.
Is Bitcoin Really as Volatile as it Seems?
Bitcoin has been on a bit of a roller coaster ride of late. In 2017, its value soared to nearly $20,000 per coin, before descending to less than $14,000 by the end of the year. In February this year, Citi’s private banking division referred to Bitcoin as “the most volatile asset class,” outdoing S&P 500 stocks or gold when it came to fluctuation. Since then, however, plenty has changed.
As noted by Jay Clayton, chairman of the U.S. Securities and Exchange Commission, when the Dow’s value decline by 4.6% (on 5th February), it caused the CBOE Volatility Index to rise almost 116% on the same day, rising another 37% by 6th February, and falling almost 20% by the end of the same day. On 6th February, The Wall Street Journal noted that “Shock waves from the Dow’s biggest-ever daily point plunge rippled through the markets, sparking steep selloffs in equity benchmarks from Tokyo to Madrid.” Fortune’s Jen Wieczner insightfully pointed out that “the stock market’s wild swings are making Bitcoin’s price crashes look tame.”
What does History Say?
Pension investments tend to maintain a balance in their portfolios that are usually split into 60 percent equities and 40 percent bonds. Traditionally, they have favored so-called secure investments strategies since their raison d'être is essentially the protection of finances of each individual who has contributed to the fund. For Liew, however, “institutional investors are under-allocated to Bitcoin,” which is less of a risk than it seems because historical returns have more than compensated for the volatility, benefiting investors with a higher Sharpe ratio than standard asset classes.
Caution is Still Advised
Liew warns against going overboard when it comes to Bitcoin: “Are we proposing that institutional investors should we allocate 100% to BTC, to the exclusion of other investments? From the mean-variance framework, the answer is a resounding no.” He suggests, rather, that Bitcoin should be included in institutional portfolios after each analyst carries out their own analysis and risk assessment.
Across the globe, people have lost faith in their local currency. Liew and his colleagues see Bitcoin as a currency that lies outside the potential scope of political upheaval and other major events; one that is subject to a similar scepticism as that which arose when paper money replaced gold, and also one that is probably just as inevitable.
