Markus Thielen is the CEO of 10x Research. He spends most of his time researching digital assets and providing insights based on data. I’m excited about his contribution in sharing a practical, unbiased approach for evaluating bitcoin allocations within a portfolio. Markus is the co-author of Crypto Titans: how trillions have been made and lost on the cryptocurrency markets.

In the section Ask an Expert, AJ Nary (head of HeightZero, BitGo) answers questions from asset managers when they consider digital asset investments.

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Institutional investors embrace Bitcoin and sacrifice traditional assets

Investors continue to look for alternatives to optimize portfolio allocations. Bitcoin could be classified as a building block for institutional investors using a practical, unbiased, and proven approach.

Bill Gates was convinced by Warren Buffett to diversify away from Microsoft when he became his friend. Gates held 45% of Microsoft after its IPO in 1986. Microsoft’s market cap is $3 trillion today and Gates owns just 1.38%. If Gates had kept his original stake, he would have a net worth of $1.35 trillion rather than $124 billion.

Not everyone is lucky enough to be the founder of a highly valuable company or to be able put all their eggs into one basket.

Harry Markowitz, Nobel laureate in economics, said that diversification was the only way to get a free lunch on the financial markets.

The optimal allocation of a portfolio is usually based on the expected return or volatility of assets within the universe of investable assets. The result shows the optimal allocation for an expected return or level of volatility.

Markowitz developed a method to select investments that maximizes their returns while maintaining an acceptable risk level. This is the Modern Portfolio Theory. Fischer Black and Robert Litterman adapted the MPT concepts and added investors’ expectations of returns. The Black-Litterman Model allows investors to apply their own opinions and optimize the asset allocation. MPT uses only historical data and assumes that the same returns will be achieved in the future.

Pension funds, endowments, and registered investment advisers (RIAs), instead of using a 60/40 portfolio, can work with clients to optimize allocations according to their expected returns, risk tolerance, and volatility. The $400 trillion investable market includes equities and bonds as well as other fixed income products, such a loans, high yield, municipal bonds, listed property (REITs), and alternative investments, including private equity and hedge fund.

Bitcoin ETFs, which represent digital assets in secondary markets, are worth a modest $1.6 billion, but they can be used to optimize portfolio allocations and diversify them further.

David Swensen, a late investor, standardized diversification in endowment funds through his Yale Model. This model emphasizes diversification among various asset classes and focuses on alternative investments, such as real estate, private equity, hedge funds, and natural resources. Swensen disclosed in 2018 that two cryptocurrency funds were part of his investment portfolio. Yale Endowment, which he led, would likely have added bitcoin ETFs to its asset allocation portfolio, even though he died in 2021.

Institutional investors often ask themselves what role bitcoin can play in their portfolios. Black-Litterman explains that the answer is dependent on historical returns, risk tolerance and expected returns in relation to other assets.

We standardize nonliquid investments in real-estate through REITs and hedge funds, and private equity exposure via listed alternatives such as the UK’s Man Group, or the share performance by Blackstone. This allows us to build liquid portfolios that are based on three characteristics: historical return, acceptable risk, and expected return.

A typical asset allocation suggests 19.1% exposure in equities. 16.8% is allocated to real estate. 44.8% is fixed income. And 19.5% goes to alternatives. Bitcoin, on the other hand, would only make up 0.58% of the alternative bucket based upon its market capitalization.

Exhibit: Asset class suggestion based on Black Litterman Asset Allocation Model if Bitcoin exceeds stocks (Bitcoin>VTI), by 10%, 20 or 30% in the next year, with Portfolio Volatility targets of 7%. 10% or 12%.

When optimizing our Black-Litterman Portfolio with a modest volatility target of 7%, we observe that, if we make a forward-looking assumption that bitcoin will outperform the (US Vanguard Total Stock Market Index) (VTI) over the next 12 months by 10%, bitcoin’s allocation to institutional portfolios will increase from 0.58% up to 1.61%. A positive outperformance of 20% or 30% would justify a bitcoin allocation between 3.27% and +4.32%.

According to our Bitcoin outperformance assumption, increasing our volatility target from 10% to 12.5% would suggest that bitcoin be allocated to a portfolio weighted position of 10.36% to 10.05.8%. As the bitcoin outperformance assumption increases, fixed income assets are reduced and alternative and stock allocations increase.

Allocating away from fixed income, and increasing allocations into alternative investments such as bitcoin, a higher risk tolerance will push the expected returns towards the right of the distribution.

Investors are rethinking the risk they’re willing to take on fixed income due to unsustainable debt levels and unpredictable inflation. Bitcoin is now a legitimate investment option thanks to the ETF listings. Our Black-Litterman Portfolio Optimization shows that, depending on the portfolio volatility target and the return expectation of investors, portfolios can allocate anywhere from 1.61% up to 10.58% into Bitcoin.


Exhibit 2. Global Investable portfolio weights and Black-Litterman simulation (2)

: Markus Thielen : CEO of 10x Research


Q. What should asset managers think about when adding digital assets to their portfolios?

Asset managers have a unique chance to introduce digital assets to their portfolios after the SEC approved spot bitcoin ETFs back in January. It is important to keep in mind the following when creating a disciplined investment strategy for digital assets:

  • Consider the pros and cons of direct versus indirect exposure. Start by evaluating the fee structure, liquidity, tax implications and alignment of portfolio objectives.
  • Analyze the impact that investing in multiple digital assets will have on your strategy, as well as the overall impact digital assets will be to your current strategy.
  • Research and monitoring on a continuous basis – Develop a comprehensive framework that will allow you to stay abreast of the latest regulatory developments, market dynamics, and emerging trends in the digital asset sector.
  • Education and communication with external clients/investors – educate them about the challenges and benefits of digital assets, while managing their expectations.


Q. What role do asset managers envision digital assets having in the future?

Spot bitcoin ETFs are just the beginning of the exciting opportunities for diversification and portfolio construction that digital assets offer. Other assets, like ether and stablecoins, may have applications in investment strategies. Asset managers who want to be ahead of the curve may choose direct investments rather than waiting for SEC approval on other ETFs. Bitcoin correlations between asset classes change over time, and can be a valuable addition to other assets in a portfolio.


Q. What should asset managers be aware of regarding direct investing? And what should they seek in a digital assets partner/platform to invest with?

Direct investment involves choosing the right platform and partner to ensure your digital assets’ safety and security. Asset managers must first find a custodian who is qualified to protect their assets and minimize risk. They should also make sure that they have a platform which allows them to adapt to changing market dynamics and seize opportunities.

AJ Nary is the head of HeightZero at BitGo

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Bradley Keoun is the editor.