Crypto-assets pair great risk with mindboggling return potential. Last year’s increasing public awareness of Bitcoin’s astronomic rise sparked many questions of how to benefit from this opportunity. Since then we’ve seen increasing numbers of often particularly wealthy clients who demand to include crypto-assets in their wealth management or portfolio advice. There is a feeling that, for some reason, they are being kept out by their bank or advisor.
There are good reasons for such hesitation: the new asset class is cumbersome to invest in, highly unregulated and volatile like leveraged options; but it can also boost performance, diversify a portfolio and tickle one’s fancy.
Persephone has – for test purposes and to gain experience – incorporated the crypto currency Bitcoin (which is the largest of many and tradeable via certificates outside of complicated crypto-markets) as an asset class in its automated asset management engines. In this article we want to share some insights.
Single asset risks
Whereas the extreme volatility may be comparable to leveraged options, the attractive feature of crypto assets is their largely capital market-independent volatility. Without suffering from losses in the rest of the portfolio, a crypto asset may quintuple in value in the same time period. In contrast, most regular options are much more market dependent and thus in line with your portfolio performance overall. Crypto assets are in the current stage entirely unsuitable for hedging and should be viewed as sources of pure risk.
Modelling the individual crypto asset’s risk over a relatively short period up to one year using financial risk models of the generalized heteroskedasticity class (GARCH types) is possible with caution. Volatility clustering is equally present but possibly large asymmetries and a well calibrated News impact curve (how strongly the asset reacts to positive or negative news) are crucial.