Back to benchmarks: An intuitive framework for incorporating digital assets into diversified portfolios

The rise of digital assets has created both opportunities and challenges for investors, and financial professionals are advised to integrate these assets into multi-asset portfolios with care. Given the unique characteristics of digital assets, including their volatility and the differentiated goals of investors, a risk-forward approach is recommended. This involves first incorporating digital assets into the portfolio's benchmark, which allows for a better alignment with clients' risk preferences and objectives.

A risk-based strategy is advocated to determine the appropriate benchmark weighting for digital assets due to their high volatility. For instance, in a portfolio with 60% global equity and 40% US fixed income, a 3% allocation to bitcoin would account for 11.4% of the total benchmark risk. In a portfolio entirely composed of global equities, a 6% allocation to bitcoin would represent 16.4% of the total benchmark risk. These examples illustrate the significant impact digital assets can have on portfolio risk profiles.

It is advisable to fund digital asset allocations from other high-risk assets, such as emerging market equities and high-yield bonds, to maintain a balanced risk exposure. Additionally, reallocating some investments from the riskiest assets to safer options like US Treasuries can help stabilize the portfolio and mitigate overall risk. This strategic approach aims to optimize risk-adjusted returns while accommodating clients' varying risk appetites and investment goals.