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Trading  | January 7, 2018

Days after bankers began pressuring African central banks to allocate their reserves to Bitcoin, researchers from a consulting firm and a pension fund make the case for institutional investments in cryptocurrencies.

A traditional portfolio of stocks and bonds versus a portfolio with a 2 percent allocation to Bitcoin.

Authored by Amy Whyte via Institutional Investor,

Bitcoin is largely unregulated, “very volatile,” difficult to hold – and should be included in institutional investors’ portfolios, according to a research paper by a hedge fund consultant and pension fund investor.

The case for investing in Bitcoin comes from Jim Kyung-Soo Liew, a finance professor at Johns Hopkins’ Carey Business School and chief executive officer of SoKat Consulting, and Levar Hewlett, a quantitative risk management associate at the Maryland State Retirement and Pension System. In a paper posted last month on research database SSRN, the authors pointed to the cryptocurrency’s “unique diversification benefits” and “attractive” risk-return profile.

“Institutional investors are under-allocated to BTC,” Liew and Hewlett wrote in the paper.

Bitcoin — the largest electronic currency with a market value of $253 billion on January 2 according to CoinMarketCap — had a rollercoaster 2017, soaring above $19,000 per coin before plummeting below $14,000 in a year-end rout. In December, two U.S. exchanges began trading Bitcoin futures, offering regulated trading options to investors.

According to Liew and Hewlett, the historical returns of Bitcoin have compensated for the “high degree of volatility,” yielding a higher Sharpe ratio than any standard asset class. They also found the cryptocurrency to be “surprisingly interesting from a diversification perspective,” as it’s uncorrelated to other investments.

“Are we proposing that institutional investors should allocate 100 percent to BTC, to the exclusion of other investments? From a mean-variance framework, the answer is a resounding no,” they wrote. The optimal allocation, according to Liew and Hewlett, was 1.3 percent over the period between August 2010 and October 2017.

“For those CIOs who are lagging behind industry peers and need to add riskier, and thus more rewarding, investments to their portfolio, cryptocurrencies are an investment worth considering,” the authors said in the paper.

The pair went on to recommend that institutional investors educate their staffs about blockchain and electronic currencies, while noting the underlying risks. They suggested a diversified exposure to digital currencies to protect against a Bitcoin crash, pointing to Ethereum and Litecoin as possible holdings.

“We believe in the long run that the early institutional adopters will benefit,” Liew and Hewlett said.

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