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With cryptocurrencies such as bitcoin surging in value, a question confronting investors is what role should it play in a standard portfolio.
Many strategists would reply, zero, given the relatively short history of these assets and their still uncertain role going forward.
John Normand, head of cross-asset fundamental strategy for JPMorgan, has studied the issue, and, like many, he doesn’t see a big role for cryptocurrencies. But Normand didn’t discount its use altogether.
“Small (up to 2%) allocations to cryptocurrencies still improve portfolio efficiency due to high returns and moderate correlations, but the persistence of this diversification effect is questionable from both ends. Current prices are so far above production costs that mean-reversion lower in returns is a recurring concern. Also, the mainstreaming of crypto ownership is raising correlations with cyclical assets, potentially converting them from insurance to leverage,” said Normand.
He said cryptos don’t work as a hedge for stocks — particularly against fiat currencies like the dollar that enthusiasts hope to displace.
“To the extent that bitcoin remains an investment vehicle rather than a funding currency, it will always lack the short base that sponsors U.S. dollar (and Japanese yen and Swiss franc) strength during periods of acute market stress,” he said.
Even after a decade, cryptocurrencies are still about four times more than equities or gold GC00, -0.19%, he added. And the ratio of the bitcoin market price to its cost of production is over 3.
Furthermore, the mainstreaming of cryptocurrencies — notably with retail investors — is raising its correlation with all cyclical assets. “If sustained, this development could erode diversification value over time,” he said.
Over the last 12 months, bitcoin BTCUSD, -9.05% has surged 278% and ethereum ETHUSD, -9.65% has leapt 649%. The S&P 500 SPX, +0.16% has gained 16%, and the dollar index DXY, -0.38% has dropped 8%.
