The wealthy are increasingly diversifying their investment opportunities beyond traditional assets. Alternative investments have gained significant traction. Cryptocurrency delivers advantages for the modern portfolio that other alternative assets cannot match.
Alternatives generally attract investors who want to enhance returns and reduce portfolio volatility. Alternative investments include real estate, private equity, hedge funds, commodities, and collectables like art or wine. These assets typically have minimal correlation with traditional markets, providing diversification benefits.
Yet many alternative investments come with significant drawbacks. They often require substantial minimum capital commitments, impose lengthy lock-up periods and are characterised by illiquidity. Private equity funds, for instance, could tie up capital for seven to 10 years. Real estate transactions can take months to complete. Art pieces may sit in galleries or storage for years before finding the right buyer at the right price.
Grayscale, a leading crypto asset manager, recently produced a report, “Crypto in Diversified Portfolios”, which suggests that crypto could substitute for existing allocations like gold, commodities, small-cap equities or certain private investments.
The report says the crypto market is characterised by significantly higher volatility than traditional assets like stocks, but the higher risk is rewarded with higher returns. The market also has a low correlation with traditional assets and high momentum, where gains tend to follow gains and losses follow losses.
Research suggests that allocating about 5% of a well-diversified portfolio to cryptocurrency provides the optimal balance between risk and reward. This moderate allocation can significantly enhance overall portfolio performance without introducing excessive volatility.
For South African investors, cryptocurrency offers the additional benefit of preserving the limited offshore investment allowance
Why 5%? This allocation is substantial enough to meaningfully capture upside potential during cryptocurrency bull markets yet constrained enough to protect the broader portfolio during periods of crypto market volatility.
Unlike most alternative assets, the crypto market never sleeps. This always-on market access provides unparalleled liquidity compared with other alternative investments.
For South African investors, cryptocurrency offers the additional benefit of preserving the limited offshore investment allowance.
While bitcoin remains the flagship cryptocurrency, the digital asset ecosystem has matured considerably. Ethereum has established itself as a foundation for decentralised finance. Many altcoins (coins other than bitcoin and ethereum) offer higher risk and rewards (buyer beware — do your research).
If you’re new to the market, consider that bitcoin has experienced four major drawdowns in its history, with an average peak-to-trough decline of 77%. Smaller drawdowns of 10%-20% have been frequent, even during appreciation phases. The asset should not be considered defensive, as it’s positively correlated with equity markets and typically declines when risk aversion rises.
The high volatility and potential for significant drawdowns make it essential to approach crypto allocation cautiously as part of a diversified strategy. A disciplined 5% allocation provides the sweet spot for capturing upside while managing downside risk.
Consult a qualified investment adviser before making investment decisions.
Reitz is GM for Africa and Europe at Luno
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