You're looking at all the posts published under the tag Investments.
/ Ampleforth

Ray Dalio: Correlation 'Holy Grail'

Ray Dalio: Correlation 'Holy Grail'

In the video “Ray Dalio breaks down his ‘Holy Grail’”, he sets out to break down what were the marginal benefits of diversification within a portfolio. Ultimately, using the graph below, Ray Dalio broke it down into 3 pieces: Risk, which he called the standard deviation, the number of assets or the sample size, and the correlation of the bets.

Ray Dalio Discusses His Diversification "Holy Grail" 

What he found in doing so was the higher the correlation between assets in a portfolio, the lower the ability to reduce risk by increasing the number of investments. Essentially what this means is if you take a group of investments that are 60% correlated, there is no real reduction in risk after adding more than 4 investments to the portfolio. It’s only in diversifying your portfolio that allows you to cut your risk.

Correlation of Assets Impact on Risk and Return

Dalio says for an ideal return on investment, investors should find 15-20 good, uncorrelated return streams, as that will allow for the most return on investment while cutting risk. In taking 15-20 good investments, with a 0% correlation, using Dalio’s chart, the return to risk ratio is 1.25, meaning the probability of losing money in a year is 11%. With any one investment with a 10% risk, the probability of losing money in any given year is 40%, almost 4 times as much.

What this all boils down to is the power of diversification in balancing risk. There is no great 1 best investment, but you are able to improve your return to risk by 5 times as much when diversifying across 15-20 good investments.

Since Bitcoin was created, it has shown to be an asset that is uncorrelated to the stock market. This provides investors with a tool for diversifying their portfolio, but many investors prefer to have more than one tool. Since Bitcoin thousands of altcoins have come onto the scene. Combining Bitcoin, all altcoins and all future projects has the resulting effect of an entirely new asset class: Digital Assets.

That begs the question: How does this relate to digital assets? You need only look at Bitcoin and the subsequent other similar coins found in the market to see the issue in diversifying your digital assets. Correlations within the crypto space are for the most part high, but there are a few different coins that break the mold of digital assets, which allows investors to diversify and improve their return to risk. One such token is Ampleforth, whose movement pattern in reality should have a much lower correlation to Bitcoin. For those who subscribe to modern portfolio theory and have a mindset like Ray Dalio, seeking out digital assets that don’t correlate strongly with Bitcoin may allow investors to improve their return to risk, while digital assets on the whole may help reduce correlation to other traditional holdings.

To learn more about modern portfolio theory and how it can apply to digital assets, check out our piece on the subject which you can find here.

/ Cryptocurrency

Cryptocurrencies and Modern Portfolio Theory

Cryptocurrencies and Modern Portfolio Theory

Are your crypto investments truly diversified? What's missing?

Every investor that wants a diversified portfolio should have exposure to cryptocurrency assets — or digital assets as they are sometimes called. Digital assets make up an asset class that has more volume every year and has shown to be uncorrelated to the stock market. One digital asset in particular, Bitcoin, has outperformed the S&P 500 since its inception, and is the best performing asset of any type over the past 10 years. Even Mike Novogratz the Founder and CEO of Galaxy Digital has said every Hedge Fund should hold 1% of their entire Portfolio in Bitcoin as a hedge to the systemic market risks.

In all markets, being correlated with how well the economy is performing has distinct advantages and disadvantages. If the economy is doing well, it often has low unemployment rates, strong productivity and controlled inflation. In these periods of economic boom, it’s good to have assets that perform accordingly. But when the economy starts to slow down and sentiment from markets shift, it is important to have a portion of your portfolio that takes advantage of the market downturn. Traditionally this is achieved through derivatives of underlying assets; however, in recent times cryptocurrencies have provided another way to add non-correlated assets to any portfolio.

What is Modern Portfolio Theory?

Modern Portfolio Theory suggests that the return of an asset should follow the amount of risk that asset has. This means that if an asset has a lot of risk then you should be expecting a higher return from that asset.

Those who subscribe to Modern Portfolio Theory target the best performing assets in multiple industries and asset classes including stocks, bonds, commodities, and in today’s market, digital assets such as cryptocurrencies and smart commodities. These types of investors aim to reduce correlation among the assets they choose for their portfolio, so that they can target high returns, but hopefully hedge downside by choosing assets that move in an unrelated (or uncorrelated) fashion to each other. Investors then weigh their allocations of each asset in their portfolio to maximize returns, as well as to additionally hedge their risk by securing assets that have different levels of correlation to the broader economy.

In today’s market, there is a new opportunity to introduce a diverse asset that has it’s own unique risk/reward profile and a brand new level of correlation to traditional asset classes. That new opportunity is, of course, digital assets like Bitcoin. Having digital assets in a portfolio can add a previously unattainable level of asset mix to an investor’s holdings, and can impact the level of risk and exposure an investor has in a potentially positive way. It’s also quite realistic for retail investors to be able to attain digital assets if they so desire. Digital assets like Bitcoin, Ethereum and other altcoins have provided the first opportunity in recent history for retail investors to add unique assets to their portfolio without requiring them to meet minimum net worth thresholds.

But what is uncorrelated with Bitcoin?

With the critical role uncorrelated assets play in modern portfolio theory, it’s important to hold assets that perform in an uncorrelated way to their broader asset grouping. In the digital asset world, we’re currently in a period of time where price discovery is a metric that gets a lot of attention by the media and it outlines an approach that a majority of crypto investors attempt to use to value and evaluate digital assets. Within the digital asset bucket, it’s important to have alternatives. This is because historically, virtually all digital assets follow Bitcoin’s price movements closely. Investors in digital assets need to have an alternative to current day cryptocurrencies in order to hedge and perform well when the broader asset class is down. With a redundancy in performance from cryptocurrencies following Bitcoin’s price movements, where can we find a digital asset that performs in an uncorrelated way?

Enter Ampleforth. Ampleforth is the first sound money with an elastic supply. The unit is called the AMPL. AMPLs are a completely different crypto model that spreads price information into supply. The Ampleforth protocol aims to achieve price-supply equilibrium, and it does this by expanding or contracting the amount of AMPL for every wallet holder at the same time every day: 4pm EST. This daily expansion or contraction is rules-based and transparent you can find the expansion or contraction rate at the AMPL dashboard. This daily event can lead to a different movement pattern for AMPL than Bitcoin and other cryptocurrencies. Should AMPL show to be uncorrelated over time to other digital assets, that could make it a very interesting tool for portfolio construction. This is because finding digital assets that are uncorrelated with Bitcoin can be advantageous in every crypto portfolio, in the same way that crypto can be advantageous in every asset management portfolio.

Out of all of the industries where investors hope for high returns, where risk and return run hand in hand, digital assets are at the top of the list for many of today’s investors. As the world continues to innovate, and digital assets add to and improve on the options we have for transacting, storing value and even creating new synthetic commodities, it’s important to consider assets that not only capture potential upside, but also include some assets that have their own price movements uncorrelated with Bitcoin. Should AMPL generate movements that differ from Bitcoin in a random way, AMPL could very well be the tool institutional and retail investors need to achieve the risk/reward balance missing from the digital asset space today.