Then we also explained that if I want to create a risk parity strategy, it is better to use the Ulcer Index (Ulcer Index, a practical application) instead of the abused volatility that fails to recognise whether there is a positive or negative trend.
Using the Ulcer Index, we have created an index composed of Gold and Bitcoin that has a track record (albeit back-tested, stellar), now it is time to see how a Bitcoin & Gold index can increase the risk-adjusted return (i.e., the risk-adjusted return assumed) of a traditional portfolio composed with varying percentages of the world stock market and a popular global bond index, namely the Global Aggregate Bond Index.
To do this, we first calculated the 10-year return and volatility of both indices, and then combined them in incremental steps of 10%.
In fact, the first portfolio, which is dark red, has 100% in Global Aggregate Bond and 0% in MSCI World, then the lighter red has 90% in bonds and 10% in equities, and so on down to the purple one which has 100% invested in MSCI World and 0% in Global Aggregate Bond.
Obviously, these portfolios are arranged along the so-called efficient frontier, i.e. a curve where return is maximised or risk is minimised according to the percentage of each asset in the portfolio.
Now the question is: can this risk/return ratio improve if I introduce a 5% share of BTCG, i.e. the Diaman Bitcoin & Gold index into the portfolio?
Before answering this question, it is correct to analyse the correlations between the various parties involved, to understand whether Bitcoin or Gold make sense to be introduced in an investment portfolio
As can be seen, both Bitcoin and Gold have a low correlation with the stock markets and even less with the bond market, a feature that bodes well for an improvement of the efficient frontier in Figure 1, especially with the introduction of the BTCG Index, i.e. the Diaman Bitcoin & Gold Index.
In fact, it can be observed that the introduction of a mere 5 per cent not only increased the (past) return, but also reduced the volatility, an effect that leaves no doubt as to the importance of including both Bitcoin and Gold, actively managed like this index in an investment portfolio.
This effect becomes even more pronounced if we include 10% BTCG in the portfolio, as can be seen in the graph above.
But then, if I put 20% in the portfolio, what effect would I get?
In fact, as the percentage of BTCG increases, the expected return increases and volatility decreases, although from 10% to 20% volatility remains almost unchanged compared to only 10% weight in portfolios.
20% of an index composed of Gold and Bitcoin might seem like a lot, in reality there are many so-called 'Lazy Portfolios' that make use of such percentages and sometimes more Gold in the portfolio.
The Lazy Portfolios originated from the idea of Ray Dalio, founder of Bridgewater, one of the largest and most famous hedge funds in the United States, to create a portfolio that is good for any market situation, which he called All Weather, or all seasons.
Over time, different versions of the Lazy Portfolio have evolved and been presented, the most famous being the Golden Butterfly and the Permanent Portfolio.
While in 2023 Ray Dalio was quite sceptical about Bitcoin (although he had bought a little bit of it for his hedge fund), by 2024 he had completely changed his mind, as witnessed in this infographic:
Without wishing to go into the merits of his legitimate and opportune change of mind (only fools never change their minds), let us try to see how BTCG might impact a Lazy portfolio, starting with Ray Dalio's own portfolio:
The All Weather consists of 30 per cent Large Cap equities, 40 per cent in long-term bonds, 15 per cent in medium-short term bonds, 7.5 per cent in commodities and 7.5 per cent in Gold.
Over the past 10 years, this portfolio has returned 5.1% with a volatility of 8.5%.
How would the return and risk have changed if BTCG at 7.5% had been inserted instead of Gold?
The return would be 6.3% with a volatility of 8.2%, in fact the choice would be 'no brainer' i.e. no further analysis would be required to replace Gold with BTCG.
If, on the other hand, we tried to consider Bitcoin a commodity and thus also put that 7.5 per cent on BTCG, the average annual return would have skyrocketed to 8.1 per cent with the volatility virtually unchanged from the starting portfolio.
