NOTE: This is an excerpt of a module from the Sharenet Crypto Bootcamp seminars that have been running in Cape Town and Johannesburg.

Quite often we have referred to 1% to 5% exposure to Bitcoin (or Crypto) as being prudent for traditional equity investors. The value varies depending on what article you read, but this is typically the maximum exposure to any one mid-cap or large-cap share in a reasonably diversified share portfolio.

The argument is that the potential upside for Crypto (in an ideal world where everything goes right) far outweighs the maximum 1-5% downside to your investable assets (assuming your whole crypto investment goes to pot). Now of course there is the argument that Crypto is speculative and not an investable asset but there are strong arguments both for and against this, so we will not debate this point here. Instead let’s show how a small bit of Bitcoin could have boosted your investment portfolio.

The main response from many investors is why bother with a 5% exposure to Bitcoin (for example) when looking at one’s investable assets. This normally comes from people who do not understand the asymmetric nature of Bitcoin returns relative to traditional assets. The best way to demonstrate this is to look at the returns of two portfolios, one solely invested in the J200 (TOP40) via a SATRIX or equivalent ETF, and the other which is an initial investment of 95% J200 and 5% Bitcoin. The returns are shown below, taking daily closing LUNO exchange prices:

Since May 2015 (the farthest date back we have been tracking LUNO prices) a JSE investment would have returned a frustrating 10.88% (excluding dividends) whereas if you had just allocated 5% of your initial holdings to Bitcoin, your total returns would have been a stunning 107%

And there is the asymmetry in its full glory. A conservative 5% initial speculative crypto component to your portfolio delivered outsized overall returns. And if Bitcoin had completely blown up, at most your equity would be 5% poorer. This is a massive risk/reward ratio. The rewards are outsized compared to the potential maximum risk. What’s not to like about this?

Now there is a valid argument that the investor who followed this strategy would be left sitting with a portfolio heavily weighted toward Bitcoin assets. In fact, the 95%/5% ratio would have migrated to 50%/50% as shown below:

If your objective was great risk-adjusted returns then this 50/50 weighting will not bother you. But the risk profile of the portfolio has obviously changed substantially given Bitcoins 50% weighting now. For those wanting the Crypto exposure not to deviate too far from 5%, a more prudent approach would be to regularly rebalance your assets to maintain that 95% stocks to 5% crypto balance. We have shown the results below based on annual rebalancing:

With annual rebalancing, to ensure Bitcoin doesn’t dominate more than 5% of your exposure, would have yielded a 45% return against the JSE’s 11% return. This is still a huge difference. You increased your returns 4-fold by risking 5% of your equity. Asymmetrical poetry.

The chart below shows how your percentage exposure to JSE stocks and Bitcoin would have fluctuated during this strategy, with rebalancing to bring stocks back in line with 95% exposure every June. You can see the rebalances when the JSE allocation spikes up sharply to rejoin the 95% mark, when you sell your Bitcoin profits and move them into more TOP40 exposure. Also, you can see that with the annual rebalancing strategy, your crypto exposure in the portfolio would not have exceeded more than 19%

What about quarterly rebalances? An example is below where we can see returns drop slightly from 45% to 35% over the same period.

Rebalancing monthly hardly makes any changes to the quarterly rebalancing method’s returns in the above example, and given the higher transaction fees we do not see any merit in rebalancing more than quarterly. The chart below shows how your percentage exposure to JSE stocks and Bitcoin would have fluctuated during this strategy, with rebalancing to bring stocks back in line with 95% exposure every quarter (at the vertical lines.) You can see the rebalances when the JSE allocation spikes up sharply to rejoin the 95% mark, when you sell your Bitcoin profits and move them into more TOP40 exposure. Also, you can see that with the quarterly rebalancing strategy, your crypto exposure in the portfolio would not have exceeded more than 11% before being rebalanced back to 5%

Now this strategy presumes Bitcoin will continue its rise. For the last year our regression forecasting model has held fast, and if it continues to hold fast we should finish up 2017 with $7,000 a Bitcoin, or North of R90,000 per coin.

To summarize, a little bit of Crypto exposure, 1-5%, coupled with quarterly or annual rebalancing can go a long way to supercharging your investment returns. On the assumption that the Crypto assets are appreciating much faster than the JSE assets, then your JSE account will be subject to continual purchases whilst your Crypto exchange account will be subject to continual disposals to realize profits and fund the JSE purchases. This isolates any tax events to your Crypto exchange account. And on that point, please note that tax deductions for profits realized on the Crypto assets disposals and dividends on your JSE portion were not taken into account on the above exercises.

If you would like to enquire about the full-day seminar we have on cryptocurrency and Bitcoin mining, which automatically gives six months access to the SA Crypto Club, please contact Jerome on 021-700-4828 (email jerome@sharenet.co.za) or Megan on 021-700-4828 (email megan@sharenet.co.za)



Dwaine van Vuuren

Retail-side Research

RecessionAlert, Sharenet Analytics



Dwaine van Vuuren is a full-time trader, global investor and stock-market researcher. His passion for numbers and keen research & analytic ability has helped grow RecessionALERT.com (US based) and PowerStocks Research (now Sharenet Analytics) into companies used by hundreds of hedge funds, brokerage firms, financial advisers and private investors around the world. An enthusiastic educator, he will have you trading and investing with confidence & discipline.