What Correlations Tell Us About the Value of Multi-Asset Crypto Portfolios
Sep 13, 2023
Originally published in CoinDesk’s Crypto Long & Short Newsletter on Sept. 13, 2023.
The ongoing battle between the U.S. Securities and Exchange Commission and prospective issuers of bitcoin (BTC) spot ETFs is dominating current crypto headlines. An approved bitcoin ETF would increase access and signal a bullish new chapter for crypto.
Investors who limit their exposure to the small concentration of mega-cap assets formed by bitcoin and ether, however, may not capture the full value proposition of digital assets in their portfolios.
Broadening the digital asset investment universe beyond the largest single assets empowers crypto portfolios in the following ways:
Both within crypto and in the context of an investor's broader asset allocation, increasing the breadth of digital asset holdings may lead to better diversification characteristics while also avoiding the risks of single-token concentration.
Investors should consider the following two questions regarding the portfolio-level benefits of allocating to digital assets:
Does crypto provide long-term diversification characteristics versus traditional assets?
If so, is bitcoin enough to capture this benefit fully (i.e., is it worth allocating to other tokens)?
Below we look at rolling correlations of the top 25[i] crypto assets to explore these questions:
Figure 1: Rolling 60-Day Correlations to U.S. 60/40 Portfolio (Left) and to Bitcoin (Right)
August 1st, 2021 – August 31st, 2023
The chart on the left shows rolling correlations of daily returns for the 25 largest crypto tokens to a U.S. 60/40[ii] stock/bond portfolio. Over the trailing two-year period, digital assets maintained attractive diversification characteristics to traditional portfolios with an average 60-day correlation of less than 0.50 across all crypto assets, and this relationship improves for a larger set of tokens with the average 60-day correlation falling from 0.46 for Bitcoin to 0.40 for all assets.
The chart on the right shows correlations of non-BTC crypto assets to Bitcoin. The variation and overall level of correlation among the top 25 ex-BTC to Bitcoin is more advantageous than one might think. The stigma that “all crypto is the same” appears largely unfounded,[iii] with exposure to a variety of crypto sectors and fundamental blockchain use-cases helping drive token diversification.
Accessing a broader set of active management strategies
Active crypto managers focusing only on bitcoin are mostly limited to timing the market – a uniquely challenging undertaking in any asset class. Tried and true relative value investment strategies, or strategies that compare assets to one another, from traditional finance may provide longer-term solutions for those seeking uncorrelated alpha in the space.
Effectively implemented relative value strategies call for both asset breadth and sufficient differentiation among those assets. Figure 2 takes returns for the top 25 crypto assets except BTC, controls for exposure to systematic risk (roughly approximated by bitcoin), and shows the correlations between each token pair’s residual returns (i.e., ETH vs. DOT, SOL vs. LTC, etc.):
Figure 2: Top 25 Ex-BTC Crypto Token Pair Residual Correlations
August 1st, 2021 – August 31st, 2023
The goal of this chart is to roughly evaluate if the idiosyncratic portion of each token’s returns is differentiated from one another to drive meaningful relative value comparison and allow active managers to benefit from the increased breadth of the investment universe. The average residual correlation among the top crypto asset pairs shown above is 0.29. All else equal, this indicates that on average the far majority (up to ~90%) of the residual variation among these token pairs may be unique, suggesting a substantial amount of differentiation for relative value strategies to exploit.
Multi-asset crypto portfolios encompass a wide variety of fundamental use cases of blockchain technology, offering more robust diversification characteristics vs. single-token concentration and unlocking relative value active management opportunities leveraging token-specific properties both within and across crypto sectors.
[i] Source: Token Terminal, Santiment. Top 25 crypto assets were determined by the circulating market cap as of 8/31/2023, removing any assets with less than two years of historical returns data.
[ii] Source: S&P. The U.S. 60/40 Portfolio is represented by a daily rebalanced weighted combination of the S&P500 Total Return Index (60%) and the S&P U.S. Aggregate Bond Total Return Index (40%).
[iii] We denote the period in November 2022 when the crypto exchange FTX collapsed – an extreme market event during which correlations "go to 1." This phenomenon mirrors the behavior of other asset classes experiencing market crises and is less representative of the broader overall correlation structure among assets.
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