From Fringe to Foundational: The Case for Bitcoin in the Modern Portfolio

[: 00:00:00

And remember, diversification is not about predicting the future. It is about having it in the portfolio in order to be prepared for the future and for the outcomes that can occur.

Now, how you allocate to it is another really interesting point. In the old world, the pre-Return Stacking® world, if you were going to have gold or Bitcoin in your portfolio, you might have to sell one of those cash flowing assets in order to accommodate it in your portfolio. With Return Stacking®, you do not have to.

[: 00:01:59

For those who have been following, we covered why gold, and the case for gold, by looking at a paper that was pretty comprehensive about understanding the reasons why this asset was useful, why it may matter in portfolios, how to possibly stack it, et cetera, and I think a natural progression from gold was to address Bitcoin, right? Because Bitcoin and gold, Bitcoin being called like the digital hard currency or the digital asset, that is very complimentary to gold, as we have spoken to in the past.

And for this podcast, I think Mike had pulled up a couple of papers that we also wanted to talk about that really make the case for Bitcoin in portfolios. The first one is the Ric Edelman paper, which we will talk about first, and then maybe we will pull on some points from the BlackRock paper, addressing some of the reasons why Bitcoin might be a useful addition.

So Mike, why do not we pass it over to you? What do you think about the Ric Edelman paper, and what is your takeaway from what he wrote there in terms of Bitcoin being part of portfolios, and why?

[: 00:03:32

And I think now the advisor risk, the reputational risk, is no longer in owning these assets, but it is in failing to understand and allocate to them before your clients start to ask you why you did not. I think that is the overarching headline here that we want to get to. And we want to bring some clarity and some understanding, and how might you allocate to these things, and what are the reasonings behind it?

Since these papers have been published as well, we have had the passing of the Genius Act, which was that legislation that has brought into the forefront the clarity that is required, the regulatory clarity that is required around who is going to regulate it, how they are going to be regulated, and how they are going to be allowed to be put into not only non-registered portfolios, but we have also seen this starting to open up to the U.S. retirement market.

This is a clear and relevant thing to be talking about with respect to allocation to client portfolios, and they are going to start asking advisors. So I thought it was critical that we get on and talk about this in addition to the “In Gold We Trust” paper.

[: 00:05:04

And the reason it was one percent is because if you lose one percent, it did not matter. But there is so much potential here that it could actually provide significant, if you are doubling that one percent, it actually might matter if you are rebalancing and taking advantage of the diversification of that Bitcoin.

But what has changed since is the fact that you talked about the Genius Act. You talked about Trump being pro-Bitcoin in the beginning before he was elected, talking about how he was going to do something about it. He has now done something about it in passing enough legislation that makes a lot of sense.

And so all of a sudden, a lot of these risks have been set aside and as you said, the allocation has not gone from one to two for Ric. We will talk about what he recommends at risk levels, but there has been that drastic change, that risk reduction from a regulatory perspective, from the biggest market in the world.

And now as you said, the conversation cannot be about, just, I do not do Bitcoin. People are clearly asking and demanding about it, and it is going to be part of our lives. And now it is a matter of understanding its unique reasons to exist.

[: 00:06:28

[00:06:29] Rodrigo Gordillo: Let us talk about what Ric said. What did Ric say about the Bitcoin as a portion of somebody's portfolio?

[: 00:06:34

[00:06:52] Rodrigo Gordillo: Yeah.

[: 00:06:52

And he looks at, first thing is longevity. So people are living longer, their financial assets are going to have to last a bit longer, and so what is the opportunity for traditional assets to be able to deliver on that, especially into his next point, which is, this is a disruptive technology, and he makes some correlations to the internet and how it disrupted media and how it disrupted communications.

When you get that type of disruptive technology, it might be that stocks are not where the winners in that exist. Maybe it is in the crypto space where these new companies or new approaches are going to be starting to be developed and have market cap. And if you are only doing stocks or you are only investing in stocks, you do not have any access to those types of assets.

So you have got longevity, you have got disruptive technology, the internet, internet of Money 3.0, cross border payments. And then he did talk about regulatory clarity and the regulatory burden and things like that.

[: 00:08:11

[00:08:12] Mike Philbrick: And then he…

[: 00:08:13

You combine that with the fact that you have not just Coinbase, which was still considered a fringe asset traded in the U.S. stock exchange, but now you have Fidelity digital asset platform that is legitimately doing some, making it as easy as possible for people in Tradify to really be able to use it seamlessly in their portfolios, to be able to collateralize it, to trade on it.

It is just becoming easier and easier. You have got the BlackRock Bitwise ETF that really makes it just as easy to own it as GLD for gold, right? So all of these things from a regulatory standpoint, the adoption, that it is becoming safer from a regulatory perspective, plus also the machines that are starting to come together and make it possible for the average investor to invest in Bitcoin.

[: 00:09:17

[00:09:23] Rodrigo Gordillo: I did not know that.

[: 00:09:24

Now obviously you do have to deal with your own internal compliance departments, and that is a challenge that you are going to have to navigate as you go through trying to think about this asset class. Another interesting thing in Ric's paper was 50 percent of financial advisors own crypto, but only 20 percent recommended it for their clients. So again, you have got a bit of a dichotomy there.

Also, he points out, listen, if we think about assets, and you and I have talked a lot about the global market portfolio, the portfolio of all the assets in the world that nobody owns. It is the allocation of assets. If you take all the assets of the world and you say, I want to own the world in a Bogle sense, I want to be allocating exactly like the world allocates to its market cap, as it exists. And so it is the portfolio that the world does own, but very few people actually own it.

And if you look at that and you back out what would digital assets be in that circumstance, they would be about three percent. If you are at zero, you are structurally short digital assets in the portfolio, and from an efficient market hypothesis, that is also not efficient, and Markowitz would be rolling over in his grave.

So these are the types of things where you are starting to see this asset class be broadly accepted across a number of domains.

You are getting that clarity, and Ric and his company and the Council have been on the forefront of that, and also willing to meet with the compliance departments of various companies to help the compliance departments get across the line, as well as having a bunch of educational and certification processes if you wanted to actually brush up your knowledge and get your CE credits. There is a free plug for Ric.

But he does go, I think the thing he does here is he goes out on a limb, I will call it, or certainly there is some shock jockey aspect to his allocation when he says 60/40 is dead, the new allocation is, if you are conservative, you should have 10 percent Bitcoin, if you are moderate, 25 percent Bitcoin, and if you are a growth investor, 40 percent. I do not think we are going to get a lot of people…

[: 00:11:39

So you have gold being in that cap. We have always talked about how gold has been an incredible diversifier that clearly should be in everybody's portfolio. We bang the table on it for a couple of decades and have had very few biters, until now. Now everybody seems to want to have an allocation, but the real issue is why does, why should one expect a positive risk premium from a hard asset like Bitcoin or gold? Have we been able to figure that out yet, right? Put those two together. Why is it an upward sloping equity line?

[: 00:12:35

So cash flowing assets like bonds and stocks often have this interest rate of sensitivity, and non-yielding assets diversify those exposures, and they have a counterparty risk when you are talking about something that has cash flow. Gold and Bitcoin, when you hold that does not have a counterparty risk.

So to some degree, there is a diversification aspect just from the fundamental point you are making that makes them different for the portfolio, and then I think you have got a few ideas on that as well, so that there is a risk premium. So I will throw it back to you on the risk premium side for gold as an example.

[: 00:13:34

So if you have it as part of your portfolio, it will be a good diversifier, but does it actually add profit and loss? And what we found in our paper is that there is a structural risk premium that gold exhibits, and the reason that it makes sense that there would be an empirical positive risk premium.

I think gold is 2.7 or 2.8 historically, is that investors actually demand compensation for assuming inflation currency and policy risks, that when Bitcoin did not exist and when gold was pegged, especially when gold was pegged, that risk was taken on by the government. The moment the government said I am absconding of this risk, I am just passing it on to the market, you are taking, by holding gold, you are taking on certain risks that you demand compensation for. So it is a risk-based argument here as to why this risk premium would exist.

ially since it has matured in: 2018

But roughly speaking, if we are trying to identify why Bitcoin has done so well, and why we expect Bitcoin to continue to do so well, it really is due number one to their scarcity; number two, the decentralization of Bitcoin especially, but also gold, right? Nobody has the ability to print more gold. And the role as an alternative store of value.

So those three things, if we really understand their unique qualities and the fact that you are taking risks that, hey, the risks are what? There may not be, central banks may actually be more prudent and that they will print less money. Maybe there is disinflation.

Those things are going to be bad for Bitcoin and gold, but you are taking that risk as a part of a portfolio with your equities and bonds, that do well when that does not happen. That is the key differentiator. And then finally, we identify that there is an excess rate of return that actually rivals equities’ and bonds’ excess returns.

So it is not like you are necessarily taking away from future returns. In fact, you are probably making your return profile more robust, and I think Edelman talks about longevity issues here, and why these could key in terms of us living longer.

ing record amounts of gold in: 2024

And Bitcoin, with the crypto czar David Sachs and the team that is going there, they have confiscated a ton of Bitcoin and other cryptocurrencies that they are now contemplating using as part of the reserves, possibly. I imagine the next step after that is that there is going to be a thoughtful way of continuing to accumulate those as part of a gold/Bitcoin reserve.

So these are all the elements that kind of come into play for me to make a strong case for why own it, and then why they should demand a positive risk treatment. And of course, the volatility being much higher for Bitcoin, you should expect a higher excess return because you are taking on more volatility. So that is key to understand.

[: 00:17:36

And you have that on a backdrop where the world is looking for some new reserve asset to store value that is not connected to a single sovereign nation. So the backdrop against which you are seeing these assets is actually a pretty interesting regime to make sure they are included.

And remember, diversification is not about predicting the future. It is about having it in the portfolio in order to be prepared for the future and for the outcomes that can occur. And the fact that they are so different, the fact that they do not have that cashflow, that they are scared, that is what creates the different diversifying returns for your portfolio. It is the very nature; it is the very basis of how that happens.

Now, how you allocate to it is another really interesting point. In the old world, the pre-Return Stacking® world, if you were going to have gold or Bitcoin in your portfolio, you might have to sell one of those cash flowing assets in order to accommodate it in your portfolio. With Return Stacking®, you do not have to.

End miniriff here

[: 00:19:00

[00:19:01] Mike Philbrick: So you can maintain those cash flowing assets while stacking these diversifying assets on top, and that is really the beauty of bringing Return Stacking® to this particular asset class and diversifying those traditional cash flowing assets that clients know, love, and trust in their portfolio. Do not get rid of them. Absolutely keep them.

[: 00:19:27

So the key here is you can do the Edelman approach. We will see how much adoption there is for that, but the ability to recognize that, in fact, these hard assets, we can make a strong case for why they will have excess returns.

And what is excess returns? It means that it is just returns minus the cost to borrow. Meaning if I buy a gold/Bitcoin futures contract, sorry, a Bitcoin futures contract, and I expect it to have a positive risk premium, then I get the benefit of getting the equity risk premium from my 60, the term premium for my 40 in the credit premium, depending if you are using corporates, and you get to stack the excess returns from the Bitcoin holding, right? So it is a yes, and solution to the problem.

[: 00:20:34

So you can look at things like do you buy spot Bitcoin ETFs or Ethereum ETFs. So those have been quite popular, issued by the various major players from BlackRock to Fidelity.

There are also buffered ETFs that are starting to include those into the portfolio. You can look at equity exposures, the individual equities. Now I would be less inclined for that because you have that equity risk that is inside of that, or on top of that risk of the actual cryptocurrency.

You have heard of things like MicroStrategy. Now I do see a number of issues from providers coming out with more of a crypto index fund. That is something that will be interesting to look forward to where you take that sort of Bogle mindset to the crypto world and just simply own the market cap-weighted index.

And if you are doing that, Bitcoin, Ethereum, XRP, and Solana probably get you 90 percent the way there in the total exposure. Obviously, things get a little bit harder if you are trying to hold gold coins and do that on behalf of individual clients. Maybe that is more apropos for institutions who have the ability to do that sort of thing.

When you think about that from that perspective, and what we were talking about earlier when Rod was on the call, was the idea of making sure you are stacking these types of real return assets, these real assets on top of the cash flowing assets, making sure that you do not give up those cash flowing assets like U.S. stocks, in order to provide that layer of diversification.

And that is where Return Stacking® can come in handy where you maintain those exposures in the portfolio and stack these diversifiers on top. That has a number of advantages in that it prevents the inevitable tracking error that occurs when one allocates to an asset class that is unique and your building intuition from the perspective of the individual investor.

So from an allocation perspective, a couple of thoughts from my perspective. One would be, let us stack it on those cash flowing assets that clients know, love, and trust. That will help attenuate some of that diversification tracking error that occurs. A friend of ours, Brian Porter, likes to say diversification is always having to say you are sorry, and it manifests in funny ways.

Generally, investors and clients do not panic and sell things at all-time highs. They tend to do that when you get into those trying and challenging moments when it would probably be opportune to be rebalancing or allocating to, but instead, they give up on the asset or the strategy, thereby locking in those losses and not getting the commensurate gains.

If you can stack that portfolio, avoid that tracking error, avoid those behavioral vulnerabilities, that gives the end investor a better chance of having success at allocating for the long term in the portfolio as well.

[: 00:23:32

And then another thing I was going to add to that is start from a position of strength. So make the allocation small, something that you can absolutely stick with so that when the time comes to rebalance, you can do that. And then if it goes down a little bit, you would be comfortable rebalancing because that loss, temporary loss, is small enough that you can withstand it, and if it goes right when it starts to go in your favor, maybe, as Rob Arnett says, you sin a little, maybe you do not rebalance down.

Or maybe the client becomes comfortable with it and the intuition builds and you can allocate a little bit more, and you feel comfortable doing that from a position of already having a profit in the portfolio.

So thinking through the allocation strategy in that format, I think can help build that intuition for the individual clients as they climb the learning curve on these new assets that they might allocate to in the portfolio.

[: 00:24:48

And when you are doing a 40 vol, you are probably going to expect that portfolio to also exhibit something like a 60-70 percent drawdown. So let us just be careful what we mean by high risk here and saying, we are just going to, you need to add this asset cost. It is a risk beyond what any investor has ever experienced in a traditional asset wealth management setting. So that is why I think it is going to be difficult.

The way I see it is, I always see it, and we see it at ReSolve from the perspective of risk budgeting, all this stuff where you do not want the maniacs to take over the asylum, and if you are going to be adding to an allocation of Bitcoin, I think a reasonable starting point can be a couple of percentage points to 10 percent maybe.

At which point, I think we had some stat Mike where if you added Bitcoin to a portfolio up to four or five percent, then you got volatil… Maybe tell us about that.

[: 00:26:31

So now a little bit back on track and as you alluded to, when you have, you do not want a maniac running the asylum, so it is a good idea to allocate to something in an appropriate fashion. And what Bitwise did was they looked at what does a one percent allocation do? What does a two and a half percent allocation do? And what does a five percent allocation do? And what is interesting is the risk does not start to increase in a portfolio until you hit five percent. So if we look at the annualized volatility of a portfolio, and I am sharing the screen at five percent addition of Bitcoin to a total portfolio, the standard, the annualized standard deviation goes from 8.49 to 9.74. So it goes up very marginally.

As Rodrigo was talking about, it is a 60, 80, 100 vol asset, or it was 100, was 80, and now dropping to 60 as it gets financialized. But you add this crazy thing to the portfolio and in fact it does not increase the volatility much. And if you look at Sharpe ratio, the Sharpe ratio actually increases because of the asymmetric return contribution from Bitcoin. So the Sharpe ratio goes from 0.43 in the 60/40 portfolio to 0.84 with including a five percent Bitcoin allocation.

Now I will add, adding one percent or two and a half percent, both reduces the volatility, keeps the drawdowns practically indifferent, and increases the return. That is true diversification, and I think that is what you are getting at Rod, right, is that if you add these things and you add them in the right, if you add that little bit of the salt to the dish, it improves dramatically. And so that is what we are talking about.

And then the other idea is you do not have to actually get rid of that traditional portfolio. You can stack these on top rather than it being an *and* discussion rather than an *or* discussion. And so I think the Bitwise paper is definitely worthwhile adding to the reading while you are looking at Ric's paper. If you would like to increase the returns of a portfolio, or historically, what has happened is that if you have added small amounts of Bitcoin to portfolios, the returns have increased and the risk has remained stable.

And that is a wonderful diversification and a great example of how lowly correlated assets can really add value. And again, these are those real assets. Gold has a similar experience. When you add gold, it does improve a lot of the final outcomes in a portfolio.

[: 00:29:31

And so I think that is one of the reasons why these guys are allocating so heavily towards Bitcoin, but you are taking away from equities and bonds that provide balance and diversification benefits.

So there is another strong case to be made for the Yes, and for keeping the equity risk premium in your portfolio, for keeping the term premium, and then stacking the excess return on Bitcoin on top. And by the way, when you stack, you also have similar qualities here of diversification. Volatility does not add that much.

If you are adding one, two, three, four percent and then you stack another diversifier like gold within there, now you are really cooking, right? You are actually stacking these risk premiums on top of each other. Depending on your risk profile and whether you believe that true inflation is really 11 percent, you can calculate roughly what is the exposure you need in order to be able to beat that hurdle, and at the very least, maintain your purchasing power, if not beat it.

So it is about this high concentration in Bitcoin. I do not think it is absolutely necessary now that we have this type of stacking process and…

[: 00:31:23

[00:31:24] Rodrigo Gordillo: … and products out there that can do this.

[: 00:31:25

[00:31:37] Rodrigo Gordillo: Yeah. I did a Christmas episode where this whole thing started with Meb Faber, Corey Hoffstein, and Wes Gray, and everybody had to bring their best ideas, and mine was actually equal risk contribution portfolio between gold/Bitcoin because what is interesting, as I mentioned in the beginning of this podcast, is that they both seem to have similar drifts in response to similar things, but their daily correlation is zero, right?

And so when you put those two together and you expect them both to make money over time and you can continue to expect them to be lowly correlated, the portfolio construction of having both together creates a much smoother equity line and you benefit from this diversification, benefits higher Sharpe ratio, and so on.

So the interesting thing is we came up with that. Obviously, we have done a lot of work on that since, if anybody wants to dig into that. But the interesting thing is, who was it? Paul Tudor Jones goes on TV a couple of weeks ago and is pressed like, what would you, what would your bet be on in this environment where there is currency debasement, fiscal mal-prudence, et cetera?

Eventually they got him to say, what I would do is I would have an equal risk between gold, Bitcoin, and stocks. And what that turns out to be roughly is 90-100 percent U.S. stocks, around 80 percent gold and 20 percent Bitcoin.

So these are, that is interesting, from an equal risk contribution, things that will benefit in this environment, that weighting scheme is one that I really like, and as I said, there is if you look at our research, you will be able to see what we talked about, what we have launched on the back of that in really thoughtful portfolio of stacked risk premiums.

And I will say the last thing and the last benefit behind all of this is that when you are handling high volatility assets as an allocator where you have to address ticket charges and rebalancing more often than you want to, because when you are dealing with high volatility, you are going to have to rebalance if you are going to be a fiduciary. There are trading costs, there are ticket costs, there is the time invested in order to do that.

Now there are pre-packaged solutions out there where you do not have to worry about that, where you are going to be able to have somebody else deal with all the operational burden that is required to maintain an allocation to something like that and be able to rebalance on your behalf at a cheaper rate and actually have the stacking.

So I think that is another innovation in the market. There is a handful of securities that do that for investors right now, again, going back to the beginning of the podcast where we said it has become easier and easier to allocate to these things.

It is not just because you are getting direct access to Bitcoin, but because there are solutions like this that do it for you. So anyway, that is kinda my thoughts on how to allocate, how I like to allocate and it has become easier than ever to do it.

[: 0:34:34

And that will change. As we have talked about the financialization of Bitcoin as an asset, we are seeing the volatility continue to drift downward, and so in your portfolio, you might want to consider that as you move forward to have something that actually is responsive to the changes in the assets themselves, making sure that they are contributing equal amounts of volatility to your portfolio.

[: 00:35:11

Today I am actually measuring the annualized standard deviation and we are looking at 60. So the volatility has collapsed for Bitcoin, and in a way, a prudent, thoughtful way of looking at this and saying, I am not in the news for Bitcoin. I do not know what is happening day to day on the regulatory side, or is there an easy way to meet a proxy adoption or lack thereof for Bitcoin over time?

And I think volatility and price is a good way to decide whether you need to have more Bitcoin or less, because the volatility as it becomes more and more adopted, more and more adoption means lower and lower volatility. Lower volatility in a portfolio that is looking to risk balance between equities, gold, or whatever, 60/40 and whatnot, will mean that it will naturally allocate more and more to gold as volatilities come in.

Probably they are going to end up landing in the similar type of volatility profile as gold, which is around 15-16 percent now. Also, gold went from 30 to 15 over the last couple decades, and so as it comes in, you are going to allocate naturally more to Bitcoin and if it becomes less and less adopted, something happens, somebody, something else beats Bitcoin in terms of being the better crypto reserve currency, then it will have more and more volatility, and you will allocate less and less, naturally, without you having to follow any of the news.

And that is another easy heuristic to be like, all right, I want it. I do not wanna take too much risk. How do I manage it? Looking at volatility seems like a easy and prudent way to do it.

[: 00:37:03

Now, I would not want to put too much weight on the performance side of it; it is more of the clear delineated opportunities for diversification that I would want to lay my bricks on, if you will.

And the fact that we are seeing that adoption at several levels, starting with sovereign nations. And these are very serious developments for an asset class to be considered that, and it is a global asset class, like it is unknown in every single country, and now maybe some of the large companies in the S&P 500 are known like that, but most companies in, let us say the U.S. small cap or mid cap index, they are not going to be known globally and you are comfortable owning those. Anyway, just a thought.

And I think that the other thing is layering these real assets on top of the assets that are the cash flowing assets is a really magical way to incorporate them and make you feel comfortable with the allocation within the portfolio.

[: 00:38:18

That is, if you look, do the math on that, and if you look at any of our research, it is an easier way to handle periods where the diversifiers might not do so well, and an easy conversation with clients.

[: 00:39:05

[00:39:06] Rodrigo Gordillo: Yeah, and if you guys have any questions, look, we have written a ton of new research on hard assets and currency debasement. A couple of blog posts are coming up this week as well. The gold paper that you can go to Returnstacked.com and download, actually covers mostly the gold, but does discuss Bitcoin at the end there and the reasons for owning it.

And there is another article that I think is already published that talks about how these can help with currency hedging if you are a domestic investor and do not want to sell your home country bias equity market for international allocations. It turns out that most of the outperformance of your international holdings ends up being from currency appreciation.

And if you stack some of these gold/Bitcoin on top, you might actually not have to sell your domestic equities for international ones. So take a look at our website. If you have any questions, let us know, and I think we dropped the link there for the white paper if you guys wanna download it.

And if you have any questions, we are easy to reach out to. Go to the Contact Us page on that site, send us a message, or actually book a time to chat and see how all of this stuff can come together for your portfolio or your client's portfolios. All right. With that, I think we will leave it.

Mike, any parting words?

[: 00:40:29

[00:40:35] Rodrigo Gordillo: Awesome stuff. Have a great weekend, everybody.