Digital asset strategies: to diversify or not?

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By Tyrone Ross and Erik Smith

In the last 13 years, the cryptocurrency market has reached a cumulative market capitalization in the trillions. As of September 2022, Lukka Enterprise Data has listed 50 cryptocurrency assets with a market capitalization of more than $1 billion. With an increasing number of investment options to choose from, many market participants are wondering:

  • Should digital asset portfolios be diversified?
  • Can Cryptocurrency Asset Diversification Mitigate Risk in a Highly Volatile Asset Class?

Generally speaking, financial advisors and investors tend to diversify widely across asset classes and within asset classes. After all, actively choosing investments is incredibly difficult. As Craig Lazzara, managing director and global head of index investment strategy at S&P Dow Jones Indices, points out, “Returns are typically driven by a relatively small number of strong performers, lifting the index’s return by above that of most of its components”. There are decades of historical performance data to support this observation in the stock markets. Does the same apply in digital asset markets?

Let’s take a look at four S&P Digital Market Indices:

As for the data tested, over the past five years (as of September 30, 2022), the S&P Bitcoin Index and the S&P Cryptocurrency MegaCap Index have outperformed broader cryptocurrency indices on an annualized risk-adjusted return basis. The S&P Cryptocurrency MegaCap Index, which combines Bitcoin (BTC-USD) and Ether (ETH-USD) in a market capitalization-weighted index, led the way in absolute returns, posting a five-year annualized return of 36.21%. The S&P Bitcoin Index ranked second in terms of absolute return, posting a five-year annualized return of 36.12%. Similar to previous market downturns, Bitcoin has held up better than the vast majority of cryptocurrency assets in 2022.

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S&P bitcoin index performance

However, over a three-year period, Bitcoin lagged the most diversified crypto-asset indices in absolute and risk-adjusted annualized returns. The S&P Cryptocurrency MegaCap Index, which includes Bitcoin and Ethereum, led the way during this time period (see Exhibit 2).

S&P Cryptocurrency Megacap Index Performance

As we can see in Exhibit 3, Ethereum’s share of the total crypto asset market capitalization has grown slightly since the beginning of 2017, now accounting for more than 17% of the total digital asset market. The market capitalization of Bitcoin, which accounted for roughly 90% of the cryptocurrency market in early 2017, has fallen to a dominance of around 39%. This is still a high percentage compared to most asset classes.

Bitcoin vs ethereum market cap dominance

So how might Bitcoin’s diversification have affected portfolios? The data suggests that diversification would have resulted in higher absolute and risk-adjusted returns over the past three years, while Bitcoin underperformed over the past five years.

exposure 4

final thoughts

As with any investment portfolio, time frame, risk tolerance, and risk capacity all play a key role. Just as investors had a hard time assessing which technology companies would thrive after the internet boom of the 1990s, it is equally difficult to predict which cryptocurrencies will gain or lose market share in the future. With limited historical data on which to base our analysis, we are left wondering what the future holds for this new asset class that is growing exponentially. The best way to make an informed decision about structuring a digital asset portfolio is to continually learn and evaluate this evolving market. Education comes first.

Divulgation: Copyright © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. This material is reproduced with the prior written consent of S&P DJI. For more information on S&P DJI, please visit S&P Dow Jones Indices. For full terms of use and disclosures, visit Terms of use.

original post

Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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