How to allocate the cryptocurrency that people love and fear: keep this ratio in mind

In conducting its analysis, Wells Fargo compared various portfolio characteristics over a four-year period. The bank used the following methodology, with the analysis using the HFRI fund Weighted Composite Index to proxy hedge fund exposures and the Bloomberg Galaxy Crypto Index to represent cryptocurrencies. Rather than focusing on a single cryptocurrency or hedge fund, we used a broader index to diversify exposures.

After looking at the results, the best result is an optimal cryptocurrency allocation of 5%-10% of the broader hedge fund allocation.

The following is a more detailed analysis of the results.

No cryptocurrency allocation: from September 2017 to July 2021, the hedge fund portfolio is assumed to have an annualized return of 7.5%, an annualized standard deviation of 8.1%, and a Sharpe ratio of 0.75. This portfolio also experiences the largest decline - 11.6% - and has a high correlation with the Russell 2000 (0.93).

Allocation 5% cryptocurrencies: A 5% reduction in hedge funds in the portfolio and a shift to cryptocurrencies resulted in an annualized return nearly 5 points higher year-over-year, with only a small closing higher volatility and roughly the same maximum decline per year compared to the Russell 2000.