Any client who owns bitcoin must understand its volatility. With a volatility of around 85 per cent, it is more than six times more volatile than gold and around five and a half times more volatile than UK shares. This is extraordinary.
The crucial thing about volatility is that it begets mean reversion. A big price move up for example signals a likely reversion down, rather than a moment to buy. This is poorly understood by commentators but is a foundational principle of capital markets.
3. Debunk the pricing approaches
A number of popular tools have been deployed by internet commentators to justify having a view on the price of bitcoin. They are all flawed. The most common approach is technical analysis. Yet in an asset class this volatile this sort of approach has almost no record of being right. It aims to assume trends and follow them. There is little evidence in the turbulent journey of bitcoin that it can maintain trends with any predictability.
Likewise, the approach that looks at trading volume as a buying signal is flawed. It assumes this is a sign of market take-up. Yet, in reality, the figure can and is manipulated by the shady ‘miners’ of bitcoin as they seek to control their own inventory of coins. The publicly available data reveals little of what will soon take place in terms of the supply of bitcoin to the market.
4. Acknowledge its performance
It is wrong to dismiss bitcoin as an asset class. Given its volatility, it can only ever make up a tiny portion of portfolios, and currently there is little regulatory scope to hold it. However, the reality is that the five-year return of bitcoin, at some 117.6 percent, justifies the volatility in mathematical terms.
Indeed, if a 1 per cent allocation is added to a mean variance optimiser to build multi-asset portfolios on an efficient frontier, then this would have helped investors with a variety of risk tolerances over the past five years. This improvement in the multi-asset efficient frontier occurs because bitcoin, for all its volatility, is a genuinely uncorrelated asset class.
5. Limit the downside
For those clients who are determined to personally allocate to bitcoin outside of the portfolio you are advising on, it is wise to remind them that this is an asset not a currency. It is far too volatile and far too inaccessible to be a currency. Therefore, it should not be seen as a store of wealth but a speculative investment. We cannot objectively dismiss bitcoin as a speculative asset because historically it has delivered a return justifying its turbulent ride.
Despite the potential impressive returns, we must encourage clients to see bitcoin in the right terms and, if anything, to only ever have a very small exposure.
