Experienced investors know that diversification across a portfolio can enhance long-term returns while reducing risk.
Today, lower interest rates and market volatility due to COVID-19 may be encouraging more investors to diversify assets and safeguard wealth beyond the usual asset classes comprising equities, fixed income, property, and cash, and into alternative investments.
One alternative asset class that has shown exceptionally high potential returns relative to risk tolerance is cryptocurrencies. These are digital currencies such as Bitcoin (BTC), Ethereum (ETH), and Ripple (XRP).
Investment in cryptocurrencies is growing. A recent global ING survey showed that almost 25% of people expect to own cryptocurrency in the future. A 2019 finder.com survey reported the number of Americans invested in cryptocurrencies nearly doubled to 14.4% from 8% just one year prior.
The famous Winklevoss twins of Facebook fame found success in their Bitcoin investments, becoming the first Bitcoin billionaires back in 2017. And more recently, billionaire and ex-hedge funder Michael Novogratz invested 30% of his fortune in cryptocurrencies, and specifically Bitcoin, what he refers to as “digital gold.”
Investors could benefit from the help of an experienced, active management team possessing strong product knowledge and rigorous risk management capabilities. This will help them navigate the ebbs and flows of cryptocurrencies,
Even with a management team, anyone considering crypto investments should have more than a cursory understanding of this asset.
Here, we explain how alternative investments, like cryptocurrencies, are compared to other types of investments. We analyze the risks involved, their performance, how to invest, and why an active manager can help maximize earning potential.
What is an alternative investment?
Beyond the usual stock and bond investments, investors are showing interest in alternative assets that don’t fit within traditional portfolios.
There are two basic types of alternative assets. The first type is non-traditional assets. This includes private debt and private equity and real assets, like precious metals, commodities, fine art and collectibles.
The second type is where investors select ordinary assets like stocks and bonds but use techniques such as short-selling to gain returns.
Historically, alternative investments were only available to institutional and accredited investors with a certain amount of investable assets.
However, in recent years, new investment vehicles, including alternative mutual funds, ETFs and cryptocurrencies have made this asset class more accessible.
Individuals seek out alternatives for a variety of reasons.
Investors will sometimes purchase alternatives because they include assets that are not widely followed by analysts. These types of assets create opportunities for significant growth because the markets may significantly undervalue them.
Other investors seek alternatives that reflect their own interests and passions; they may have an emotional connection to gold or fine art, for example.
But probably the most important reason to consider alternatives is diversification. That’s because traditional assets like stocks and bonds often move in sync, but alternatives have their own performance cycles.
For example, alternative assets like gold perform well when currency values are falling. Other assets, including global macro or market neutral hedge funds, may provide a cushion when interest rates are rising and hurting bond returns. The idea is to invest in an array of assets so that when one is down, another will be up.
Of course, alternative investments may not be for everyone.
These can be complex investments, often with long lock-up periods and high investment minimums. Yet, for sophisticated investors, these assets can make up an important element of a diversified portfolio.
How cryptocurrencies compare to traditional currencies and investments.
A cryptocurrency is a digital or virtual currency.
Unlike the U.S. dollar or Swiss franc, cryptocurrencies are not issued by a government. Central banks or other financial institutions do not govern this asset.
Units of cryptocurrency are secured by cryptography, and aren’t easily counterfeited nor can they be spent more than once. Encryption algorithms allow for secure payments online, which are denominated in terms of virtual “tokens,” or ledger entries.
Cryptocurrencies are also kept secure by the blockchain. The technology encrypts records of every transaction or sale of each unit of currency. The blockchain makes it harder to steal or counterfeit cryptocurrencies, while still protecting the anonymity of buyers and sellers.
Many cryptocurrencies are decentralized networks based on blockchain technology — a distributed ledger spread out over a wide network of computers.
Although the oldest and best-known cryptocurrency is Bitcoin, there are now thousands of alternate cryptocurrencies. Some are similar to Bitcoin — and branches of Bitcoin that split off from the main currency — but others are based on distinct technology and offer differentiating risk and return characteristics.
Unlike traditional currencies, some cryptocurrencies limit how many coins can be minted (21 million, in the case of Bitcoin). That means that the Bitcoin market can’t be flooded with currency, creating inflationary pressure. Every Bitcoin transaction is on record, and every Bitcoin holder can generally see the disinflationary monetary schedule of its future.
As a result, investors can use Bitcoin and similar cryptocurrencies as a hedge against inflation.
Are cryptocurrencies safe to invest in as an alternative investment?
No investment is entirely safe, and cryptocurrency prices can fluctuate significantly in some market environments.
Of course, such investors must be aware of the price risk and volatility of cryptocurrencies. For example, at the end of November 2015, BTC was priced around $370. By February 2017, it made its way above $1,000. In October of the same year, it rose past $6,000. In December, it almost reached a near record-high price of $20,000. Two years later it traded around $7,000 and it stood just above $6,000 at the end of the first quarter of 2020.
Investors should also be aware that cryptocurrencies carry unique risks that go beyond traditional concerns of liquidity and volatility. The act of buying cryptocurrencies outside of crypto exchanges may present certain hurdles that one wouldn’t likely encounter when buying investments in publicly-traded securities.
There are also operational risks in this still-evolving asset class, which has seen exchange failures, fraud, theft and ever-changing attempts at regulation.
Only constant monitoring and management by experts can fully protect investors from all these risks.
Cryptocurrencies outperformed U.S. stocks, bonds, gold, and other emerging currencies since 2012
Despite the risks, investment in a cryptocurrency asset class has delivered solid performance over time.
As the chart below shows, Bitcoin has handily outperformed traditional assets, including U.S. stocks, U.S. real estate, bonds, gold, and emerging currencies on a risk-adjusted basis since 2012.
Since 2012, Bitcoin has outperformed other asset types despite it being as perceived as more risky nature.
Cryptocurrency returns have been almost entirely uncorrelated to the U.S. stock market for most of the asset class’ trading history. This makes cryptocurrency a great option for diversifying assets.
Active management can add substantial value
Active, rather than passive management, can enhance the return potential of cryptocurrency assets.
Unlike the case for a majority of passively managed ETPs, active managers avoid a wait-and-see lagging approach that tracks an index.
Rather, they can take advantage of market movements, investor sentiment, and trading patterns by trading crypto assets to maximize returns.
Active managers also help investors navigate crypto’s barriers to entry, their unique structure, and their volatility.
Because cryptocurrencies aren’t as easy to buy and sell as traditional assets, effectively managing them requires expertise and care. Active management can add value to an alternative asset portfolio.
Seasoned portfolio managers at FiCAS, for instance, have been able to double the performance of actively-managed Bitcoin since launching their fund in 2015:
They have done so by implementing an investment strategy focused on growing the number of BTC in a portfolio, rather than expecting BTC to increase in value.
Trading BTC against carefully-researched top altcoins, whose fundamentals appear strong and where technical analysis indicates the price is near market bottom, will increase gains. The absolute number of BTC in a portfolio will thereby increase.
Another element of FiCAS’ investment strategy is knowing when to move into fiat (or incontrovertible paper money made by governments, such as U.S. dollars or Swiss francs).
At times, the FiCAS investment strategy purports maintaining assets in fiat for an extended period of time.
This investment philosophy provides active risk management of the clients’ investments. This is in contrast to passive investment strategies that leave clients at the mercy of market fluctuations and alone in trading decisions.
Add cryptocurrencies to your investment strategy
Cryptocurrencies can be a valuable asset to add to your alternative investment strategy. Their unparalleled performance to other asset classes can enhance potential returns while reducing overall portfolio risk.
FiCAS portfolio managers commit to delivering better-than-market performance through asset preservation, risk management, and actively managed crypto investments.
For more information about Bitcoin Capital; the world’s very first Actively Managed Crypto ETP, you can Learn More here.
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