Crypto in portfolios is here to stay — but not as a side bet

Two things I've learned as a professional investor and an amateur racecar driver — it's not about avoiding risk, it's about understanding it. To finish first, you first have to finish, as a saying in motorsports goes. Sometimes that means not taking a dangerous pass that could win you one race but cost you everything. 

The same discipline applies to allocating digital assets in client portfolios. 

With crypto ETFs attracting record inflows and major financial institutions embracing bitcoin, ethereum, solana and other cryptocurrency products, it's clear that the asset class has moved beyond silly memes and hype-chasing moonshots. It's now a serious investment that requires the same rigor as equities, bonds and other established assets.

But a critical question for investment managers and financial professionals remains: How to solve for crypto's exceptional volatility? More specifically, when allocating to this asset class, how do we avoid blowing up portfolios?

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Crypto is serious business

Crypto is a transformative asset and it's here to stay, and so too are its potential benefits for client portfolios. Applying time-tested advisor tools, including fundamental analysis, portfolio optimization and stress testing are a given. But I believe that investing in this asset class requires laser focus on risk budgeting and management, especially when even small allocations to such assets can come to dominate a portfolio's returns. 

That's why tacking a few digital asset percentage points onto a 60/40 portfolio — a strategy that seems to have become almost a default go-to move for advisors, perhaps to quell client FOMO — is not as risk-averse as it may seem. Indeed, taking any high-risk position without real investment analysis is exactly what a prudent fiduciary should not do. Crypto assets should be treated as serious portfolio tools instead of speculative betting instruments. This starts with integrating them into a risk-aware benchmark. 

To do this properly, it's critical to understand crypto's distorting effects on portfolios. Consider a recent analysis by Franklin Templeton that measures annualized volatility for various asset classes over the last 10 years. In that time, global equities featured roughly 15% volatility and U.S. bonds about 5% And bitcoin? Its volatility weighed in at 70% — or roughly five times more than equities and nearly 15 times more so than bonds.

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Bitcoin and other digital assets are, in short, forces that can turbocharge portfolios or send them plunging in the other direction. The proper allocation should be based on individual risk tolerance, investment goals and time horizon. According to the Franklin Templeton analysis, a 3% bitcoin allocation to a 60/40 benchmark funded from equities would consume 11.4% of its total risk. Adding 6% of bitcoin to an all-equity benchmark would account for 16.4% of its risk. 

These relatively high levels of risk might very well be appropriate for some investors. For most investors, however, the key challenge is minimizing downside risk while maximizing upside potential. The goal should be to capture asymmetric returns without incurring the kind of exposure that can undermine portfolio diversification and damage a client's financial well-being if prices collapse. Advisors should be prepared to rebalance such assets at least quarterly instead of the typical annual or biannual rebalancing for equities and bonds.

Mileage may vary

In the 1980s, high-yield bonds were all the speculative rage. Then it was emerging markets in the 1990s and private equity in the 2000s. All were treated as fleeting trends before getting mainstreamed by way of careful benchmarking and budgeting for risk. 

Digital assets are now going through a similar evolution, and we must begin using more disciplined portfolio construction in the space. Applying these principles through digital asset investment strategies and tokenized fund platforms will bring institutional rigor to an asset class that demands it. 

The sooner the industry adopts these approaches, the sooner digital assets can be fully rid of that gambling mentality. Because in investing, just as in racing, champions are made through disciplined risk management, not reckless speed.