Bitcoin: The New Virtual Gold? An investigation into the diversification properties of Bitcoin within a South African portfolio

Robertson, Brett Hope

Bitcoin: The New Virtual Gold? An investigation into the diversification properties of Bitcoin within a South African portfolio

Master Thesis

2018

Abstract

Using August 2010 to February 2018 as the sample period, this study investigates, from the perspective of a South African investor, the portfolio diversification and optimisation abilities and asset allocation effects of including Bitcoin in a portfolio, and compares this with physical gold. In particular the study investigates: ( i) key statistics, returns and correlations between Bitcoin’s returns and those of the components of a standard South African base portfolio and gold bullion; (ii) the risk-return efficiency enhancements and asset allocation effects (weightings) from the inclusion of Bitcoin and gold bullion under different portfolio frameworks1 ; (iii) the cumulative returns of the optimal portfolios over the investment period; and (iv) the efficient frontier shifts from the inclusion of Bitcoin and gold bullion within the context of different portfolio frameworks. Because of Bitcoin’s non-normal return distribution and extremely high returns, a quantitative mean-semivariance based portfolio optimisation approach is followed, using index proxies2 for the traditional six portfolio assets included (SA equity, SA bonds SA listed property, SA cash/money market, international equity and international cash). The study finds that, for a South African portfolio, Bitcoin (i) enhances the risk-return efficiency (measured i.t.o. the Sortino ratio) and shifts the efficient frontier up and outwards under every portfolio framework, and (ii) that it is far superior to physical gold in this regard under all portfolio frameworks, including within the asset weighting constraints imposed by South African legislation (Regulation 28 of the Pension Fund Act). In addition, at weightings of 5% or lower, Bitcoin not only enhances the portfolio’s risk-return profile, but also further reduces the outright risk of the optimal portfolio. In addition, it is found that due to its negative correlation with SA bonds and SA cash, Bitcoin’s inclusion in a portfolio increases the weighting of these assets, and reduces the allocation to SA and global equity. The above results indicate that South African investors with a higher risk tolerance should consider allocating a small part of their portfolio to Bitcoin, and that South African regulatory authorities should make provision for cryptocurrencies when drafting investment legislation (and, in particular, should consider clarifying its status within Regulation 28).

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