5% to 10% exposure to crypto is the sweet spot, says Wells Fargo

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(Kitco News) As cryptocurrencies enter mainstream finance, more and more investors want to know the best allocation percentage to these new volatile digital assets. And Wells Fargo has the answer.

In its Tuesday report, Wells Fargo concluded that a 5-10% allocation to cryptocurrencies is the sweet spot when combined with an existing hedge portfolio.

“Our analysis shows that when combined with an existing hedge fund allocation, a 5% to 10% allocation to cryptocurrencies increased the Sharpe ratio and decreased the correlation with US small cap stocks,” said said Justin Lenarcic, senior global alternative investment strategist at Wells Fargo. “Cryptocurrency allocations larger than that did not provide more efficiency, according to our analysis.”

Wells Fargo has described cryptocurrencies as alternative investments, saying that as they gain popularity, it is essential to understand the potential risks and the opportunities associated with them.

In its analysis, Wells Fargo compared various portfolio characteristics over a four-year horizon.

Here is the methodology used by the bank: “The analysis assesses exposure to hedge funds using the HFRI Fund Weighted Composite Index, while cryptocurrencies are represented by the Bloomberg Galaxy Crypto Index. Rather than to focus on a single cryptocurrency or hedge fund, we used larger indices in an effort to diversify exposures, ”the report explains.

After looking at the results, the best result was a 5% to 10% allocation to cryptocurrencies as part of the larger hedge fund allocation.

Here are the results in more detail:

No crypto allocation scenario: “A hypothetical hedge fund portfolio produced an annualized return of 7.5%, an annualized standard deviation of 8.1% and a Sharpe ratio of 0.75 from September 2017 to July 2021. This portfolio also saw a maximum drawdown of -11.6% and had a strong correlation (0.93) with the Russell 2000 Index. ”

5% Crypto Allocation Scenario: “Reducing the allocation to hedge funds by 5% and shifting it to cryptocurrencies (represented by the Bloomberg Galaxy Crypto Index) resulted in a higher annualized return of nearly five percentage points per year, with slightly higher volatility. and roughly the same maximum drawdown compared to the Russell 2000 index. “

Comparison: “Significantly higher returns with slightly higher volatility resulted in a more efficient portfolio (compared to the Russell 2000 index), evident by the 22 point improvement in the Sharpe ratio, and implies that much of the added volatility was ‘good / rising’ volatility – in other words, there were higher fluctuations in cryptocurrency prices. Interestingly, the correlation with the Russell 2000 decreased by 20 points, indicating that the addition of cryptocurrencies also improved the overall diversification of the portfolio. ”

10% Crypto Allocation Scenario: “A 90% allocation to hedge funds combined with a 10% allocation to cryptocurrencies again resulted in a further decline in the correlation with the Russell 2000, a higher annualized return, as well as a higher annualized standard deviation. However, the maximum drawdown decreased more significantly and the improvement in the Sharpe ratio was marginal. ”

More than 10% cryptocurrency allocation scenario: “Above a 10% cryptocurrency allocation – again in the context of a global hedge fund portfolio – we have seen a deterioration in the Sharpe ratio, especially as larger cryptocurrency allocations would have exposed the portfolio to a comparatively higher cryptocurrency. volatility and larger drawdowns during this period. ”

Disclaimer: The opinions expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure the accuracy of the information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is for informational purposes only. This is not a solicitation to trade in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article accept no responsibility for any loss and / or damage resulting from the use of this publication.

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