Constructing a diversified portfolio in line with the principles of Modern Portfolio Theory (MPT) is a great way to achieve superior risk-adjusted returns. MPT, in short, sets forth the concept that in order to minimize risk in a portfolio of assets, it's more important to analyze the performance of each asset within the context of the overall portfolio rather than how the asset performs in isolation. Generally, the goal of a sophisticated investor is to identify and select positive-performing assets whose performance are uncorrelated from one another so that risks and losses are isolated to one particular asset or group of assets and not the portfolio as a whole.
Ray Dalio, founder of Bridgewater Associates, does an excellent job breaking down this phenomenon and the impact of constructing a portfolio with uncorrelated assets in this video:
Bitcoin is frequently referred to as an uncorrelated asset that deserves an allocation in any diversified portfolio. At Blockhead Capital, we sought to determine whether the colloquial wisdom is true, and to what extent it holds true. We built a correlation matrix to examine the correlation of bitcoin's price performance to several other assets or indices.
Based on our review of the results over approximately the last 3 quarters, a few things stand out:
1. Bitcoin is highly uncorrelated to traditional assets classes;
2. Equity indices (S&P 500, Dow Jones, and Nasdaq) are highly correlated to one another; and
3. Gold is negatively correlated to traditional assets.
Bitcoin's consistent statistically uncorrelated nature provides an excellent source of diversification within a portfolio. This comports with the more fundamental explanation for bitcoin's uncorrelated nature, in that an investment in bitcoin is a method to opt out of the existing financial system. We hope this examination aids in your analysis of whether or not exposure to bitcoin makes sense within your investment portfolio.
Feel free to reach out with any questions or comments on Twitter: @jyashouafar.
Here are a couple additional resources we think you might enjoy: