Blackrock Weighs In On Bitcoin

Blackrock (client holding) has some thoughts about how much Bitcoin is reasonable to hold. Not surprisingly, they say 1-2% which is what just about everyone says, including me--for anyone open to the possibility that it all turns out to be nonsense. I'm not taking the Peter Schiff stance, I've owned it for a while and not planning on selling soon but it could just be internet hokum all the same.

A 1-2% allocation to Bitcoin, they say, contributes the same risk to a 60/40 as holding the Mag 7 stocks. I couldn't find where they quantified how much of a 60/40 in the Mag 7 but if we assume an index weight, the Mag 7 equals 33.55% of the S&P 500 so a 60% equity allocation would mean 20.13% in the Mag 7. 

James Seyffart posted the following from the Blackrock report that quantifies the risk added.

I have no idea if Blackrock has the correct numbers or not but it hits on what we talk about all the time here in terms of barbelling risk or volatility, depending on how you look at it, and understanding the role that various holdings offer to a portfolio. If you own the any of the Mag 7 stocks individually, you expect them to outperform to the upside. If you own a consumer staples stock with a beta of 0.6 that yields 4%, you expect it to be more of a steady eddy. 

There is a big difference though between getting that "risk" from Bitcoin versus owning the tech sector. Bitcoin is flat out risk, it could go away. With a sector, like tech, the broader you go it becomes more about volatility than risk. The tech sector isn't going to zero. 

Something horrible, like the internet bubble could happen but the sector would come back. The Technology Sector SPDR (XLK) peaked out in $60 in 2000 and it bottomed in 2002 at $12. Today, that fund is at $240. There are no doubt plenty of individual names that were in XLK 25 years ago that have disappeared but the sector is just fine. 

If you go narrower, like to semiconductors, that moves further along the scale to risk. The old Semiconductor HOLDR (SMH) which has since changed its name and the process, fell even more in the dotcom bubble. Going narrower still, the Internet Architecture HOLDR turned out be be pure risk as just about everything in that fund went to zero when the internet bubble popped and never came back. 

Today, there are more tech sector ETFs. If you buy one of them, there's no real risk, more like potential volatility and yes someone who is a forced seller after a 40% decline would be in trouble but the next time tech gets cut in half, there might be a shakeup in the constituency but the sector would come back and go on to a new high eventually. If you own the Roundhill Magnificent Seven ETF (MAGS), that takes on more risk. All seven going to zero doesn't seem like a reasonable probability but one or two of them? In the right circumstance, why not? If Tesla goes to zero, that would be an enormous and permanent hit. Risk. If you own Tesla via an S&P 500 fund and it goes to zero, that would be 2% and not too damaging. How much risk would you say you have, if you owned Tesla via client holding XLY? If you owned twice as much XLY than was in the S&P 500, your exposure to Tesla would be 3.4%. Would you think if that 3.4% crapping out as risk or volatility? In the low single digits, I'd call it volatility. I don't know where the tipping point in this context for when volatility becomes risk but all of this is different than how to look at Bitcoin. 

Bitcoin is all risk. The risk you take might be small but it is all risk. 

Marketwatch had a useful summary of a paper from Emory University that concludes the optimal retirement portfolio allocation is 33% domestic stocks and 67% foreign stocks, so no bonds. Here's a link to the paper which is 81 pages long, I didn't read it. Over a 30 year period, 33/67 outperforms 60/40 they said. Using Vanguard mutual funds below was the best I could do to recreate the result.

The 33/67 blend outperforms 60/40 by 26 basis points per year over the 28 years. The tradeoff is a much higher standard deviation, 18.01% to 11.05% and much worse max drawdown, 59.36% to 36.25%. There is nothing compelling for me from the 33/67 portfolio. The argument for more equities though, makes perfect sense from the standpoint that equities are the thing that goes up the most, most of the time. 

There are tradeoffs obviously; more volatility and larger drawdowns. People own bonds in hopes of mitigating the volatility and drawdowns of 100% equities. I'm not in that camp with bonds with duration but there other types of holdings that can function in the way people hope that bonds will. Setting cash aside for expected expenses is another way to mitigate equity volatility. The point is to have a portfolio that you can ride the entire cycle with and avoid being a forced seller after a large decline. 

And finally, I bag on the Simplify funds a fair bit but there are at least a couple that do pretty well. One I've mentioned that I think does a good job is the Simplify Hedged Equity ETF (HEQT). HEQT got a 5 Star Rating from Morningstar, so congrats to them on the fund's success. The big idea is that HEQT owns the S&P 500, sells covered calls with varying strike prices and expirations and buys put spreads below the market. 

You can see in the numbers that so far, HEQT has flirted with 75/50, 75% of the upside with only 50% of the downside. There are other funds that seek a similar result, maybe HEQT is the best of the lot, or not but there is a tradeoff to this strategy, giving up some portion of the upside. That's not a bad thing necessarily but can be the sort of thing that leads to impatience which is not an ingredient for investing success. 

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