Crypto returns compared to Traditional Markets!
It is always smart to diversify your investment risk, even more during crises. In an event of economic downturn, investors usually flock to “safe-haven” stocks, commodities, government bonds, or other highly liquid assets like cash. A well known safe-haven commodity is gold. Even though there are less riskier/safer assets than gold, like government bonds. But the flocking to gold can probably be explained by the behavioral bias of the history of gold as a safe currency.
With the advent of technology and financial instruments, the case for diversification is stronger than ever. Derivatives allow investors and businesses to hedge their risk against foreign currency, commodity prices, and stocks.
Correlation as a means to spread risk
A way to diversify a portfolio and minimize risk is to look at the correlation between your assets. The function of a safe-haven asset is that even when the stock markets go down, the safe-haven asset will not follow as hard and might even go up in value. This can be seen for gold during 2001 and 2008, after the fall of Lehman brothers.
As both charts show, before the peak and quickly afterward the downturn, gold spikes up shortly. The table below shows that the correlation between gold and the indices are basically non-existent.
Since the price of an index is highly correlated with macroeconomic data, it is fair to assume that most indices will have a high correlation with one other. The table below will confirm the assumption. Most indices correlate moderately or strongly with each other. So using ETF or CFDs to diversify in indices might not be the best way to spread your risk.
There are markets that highly correlate with each other and markets that do not correlate at all. An example would be the Bitcoin and Ethereum correlation with the big American Indices.
The table above shows little to no correlation between the two biggest cryptocurrencies with the biggest American indices. While the indices show strong correlation with each other at a correlation of above .77, the cryptocurrencies has a correlation of -.129 with the indices.
In the previous post, Bitcoin was mentioned as a way to diversify a portfolio. However, even though the post gives a well-reasoned argument about why it would be wise to add some Bitcoin to a portfolio, there are investors that rather not touch the volatile digital asset. Luckily, there are ways to limit the risk.
Like the traditional markets where professionals saw an opportunity by leveraging their knowledge to beat the markets, the same is true for the young cryptocurrency markets. Currently, there aren’t as many regulated professional institutions offering their services in this market. However, there are a few, such as Icoinic. The company uses algorithmic trading to maximize its returns while minimizing its losses. Algorithmic trading enables Icoinic to be present 24/7 at the markets and to profit from mispricings anytime. As the crypto markets are evolving rapidly, Icoinic runs several strategies to be robust and agile in the changing market environments.
As mentioned in this piece, correlations between markets is an important measure of diversification of risk. And because Icoinic wants to give the best insights to its customers, the company shares monthly reports on the correlation between its portfolio and Bitcoin and a few indices, S&P500, Eurostoxx, and the AEX.
As the tables show there is almost no relationship between the Icoinic portfolio and the big indices. Which can mean that it could be interesting to have in your portfolio as a measure to spread your overall risk.
There are multiple ways to spread risk, for example with government bonds with low yields or a more risky option like gold with more upside. Not to forget the cryptocurrency markets, even though it is highly volatile and can be risky, it should not be pushed aside for those reasons. This post shows it does have merit to hold cryptocurrencies as a way to counterbalance movements on the traditional markets. It is not necessary to hold Bitcoin or Ethereum, as this post explains investors can expose themselves to cryptocurrencies in mutliple ways, one way is by participating in a fund that invests in cryptocurrency.