Even a small amount of Bitcoin can make a difference to investment portfolios and even state pension fund managers are starting to take notice.
Jimmy Patronis, the chief financial officer of the State of Florida in the United States, asked the agency that manages the state’s retirement funds to consider investing in Bitcoin, as it has had a “material impact” on traditional investment portfolios’ returns, while also helping reduce their overall volatility.
Patronis, in a letter to the Florida State Board of Administration’s executive director, Chris Spencer, noted that Bitcoin is often labeled “digital gold” and “could help diversify the state’s portfolio” while providing a “secure hedge against the volatility of other major asset classes.”
The state’s chief financial officer may be right, as Bitcoin has indeed been shown to be a potentially good portfolio diversifier, especially when applied to traditional portfolios allocating 60% of assets to stocks and 40% to bonds, known as the 60/40 portfolio.
Brian Rudick, head of research at market maker GSR, told Cointelegraph that according to a study the firm conducted, a modest 1% Bitcoin allocation “has historically had a material positive impact on a standard 60/40 portfolio’s Sharpe ratio.”
The Sharpe ratio is a metric used to analyze the risk-adjusted return of an investment, first developed by economist William F. Sharpe in 1966. Per Rudic, the more Bitcoin is added to the model portfolio beyond 1%, the better the Sharpe ratio of that portfolio, which indicates “that a fund is generating a sufficient amount of returns relative to the increase in risk.”
“Portfolios with a 1% allocation tended to generate an excess return of about 1% annually with much smaller increases in portfolio volatility and maximum drawdown.”
Steve Lubka, managing director of Swan Private Client Services at Bitcoin financial services firm Swan, seemingly echoed Rubick’s thoughts, telling Cointelegraph that a “small Bitcoin allocation could generally boost returns for the State of Florida by 2-3% in their pension.”
Lubka added that given “pensions generally work hard to achieve a 6%+ annual return, this is material.” And given Bitcoin’s potential to increase a portfolio’s returns while actually reducing its volatility, it could be considered a powerful wealth preservation tool.
How much Bitcoin is too much?
While Bitcoin is well-known for its volatility, some studies have shown that in a traditional investment portfolio, it could act as a volatility buffer while improving potential returns.
Its potential stems from its poor correlation with traditional assets, which allows it to boost the diversification of the 60/40 portfolio, according to a CF Benchmarks report in October 2024.
The report says Bitcoin’s price “has not historically moved in sync with other asset classes,” making the cryptocurrency “an attractive investment for diversification purposes, as it can help add return potential without necessarily increasing the overall risk of a portfolio.”
GSR’s Rudick added that Bitcoin is a “diversifier of risk from a portfolio perspective due to its historically low correlation to both stocks and bonds.” He said BTC’s “immense volatility on a standalone basis makes it a very capital efficient asset from a portfolio construction perspective.”
CF Benchmarks suggests one of the main challenges of adding Bitcoin to a traditional portfolio is finding the right amount of exposure, given the cryptocurrency’s potential for outsized gains or significant drawdowns.
Drawing from historical returns, the firm found that an allocation of between 1% and 5% would have benefitted these portfolios up until September 2024.
Bitcoin's potential impact on the traditional 60/40 portfolio. Source: CF Benchmarks
Per the report, the balanced portfolio’s standard deviation only starts increasing if the BTC allocation tops 5%, if the portfolio is frequently rebalanced. Its Sharpe ratio rose from 0.5 to 0.6-0.7 over a five-year period with the addition of BTC.
Lubka summarized the impact of Bitcoin on a traditional portfolio, noting that in the low single digits BTC allocations “raise returns and actually reduce overall volatility,” but suggested that volatility increases if the allocation is more than 8%.
A Nov. 4 study by major asset manager VanEck showed that going beyond Bitcoin is also possible. A portfolio comprising 3% BTC and 3% Ether (ETH), along with a 57% allocation to the S&P 500 index and a 37% allocation to US bonds, yielded the “highest return per unit of risk.”
Source: VanEck
State pension fund reluctance
Institutional investors have generally been reluctant to invest in the cryptocurrency space, with state pension funds having to be extra careful given the nature of their funds and the historical depth of the market.
Florida’s State Board of Administration, for example, manages over 30 funds, including the Florida Retirement System Trust Fund, which has around $205 billion in assets under management. A small allocation could hover around $2.5 billion to $7.5 billion, a sum that would have had an impact on the market years ago, especially before the launch of spot Bitcoin exchange-traded funds (ETFs) in the US.
The potential market impact has to be considered along with the cryptocurrency’s extreme price volatility, something that traditionally conservative funds may not want in their portfolios.
Also, a lack of familiarity with the cryptocurrency and potential reputational risks associated with such an investment may be weighing on these funds’ investment decisions.
Nevertheless, Lukas Enzersdorfer-Konrad, deputy CEO of cryptocurrency exchange Bitpanda, told Cointelegraph that there’s been a “clear trend over the last 12 months” of traditional financial institutions adopting digital assets.
There are several factors behind this trend, including increased regulatory clarity and the launch of financial instruments that are both familiar and accessible, including the above-mentioned spot Bitcoin ETFs. Enzersdorfer-Konrad added:
“Overall, Bitcoin’s journey into institutional portfolios marks a significant shift in the financial landscape, and signals a steady, strategic move toward the legitimization of digital assets.”
Given the launch of new familiar instruments and Florida’s move to invest in the near future, the trend could soon be changing and pension funds, as well as other large investors, could move into the cryptocurrency space.
GSR’s Rubick told Cointelegraph the firm expects “pension funds to continue to explore digital assets and for some to gradually make small allocations over time.”
He said that the State of Wisconsin Investment Board has already reported it invested $164 million in spot Bitcoin ETFs.
To the market maker, the “inclusion in state pension funds would add further legitimacy regarding its place in a well-diversified portfolio, highlighting the unique benefits it provides.” To Swan Bitcoin’s Lubka, it would “positively impact Bitcoin’s public perception.”
As it becomes clearer how financial institutions and institutional investors can handle Bitcoin in a safe, regulated way, BTC is likely to keep on growing within these types of portfolios, even if the allocation isn’t too large.
