For some time now, CryptoTechFin has wanted to go a step further and offer you educational and analytical content focused on investments and finance. The goal is for everyone to be able to analyse and understand the risks and rewards of their investments.
That is why from today, we are very happy to announce the launch of our Newsletter CryptoTechFin Financial Education, which will be available on a monthly basis both on our blog and in your inbox for those of you who subscribe (instructions at the end of the post).
To inaugurate the Newsletter we have selected one of the most important investment concepts: diversification. Today we will explain what diversification is and we will analyze whether investing in cryptocurrencies can diversify our portfolio.
¿What is diversification?
You have probably read or heard the famous phrase "don't put all your eggs in one basket" or "don't bet all your money on one winning horse". These phrases refer to one of the first and most important guidelines according to investment experts, diversification. However, not everyone gets it right. Let's see why.
As a strategy, it is often colloquially said that diversification means not putting all our assets (eggs) in the same "basket" so that, in the event of a fall, we do not lose (break) them all. By spreading your investment across different risky assets, investors can reduce their overall degree of risk without reducing their expected return. So for example if we invest only in Apple shares there is a greater risk of loss than if we invest in Apple and Google. This is because in the event of a fall in Apple there is a greater likelihood that Google shares will act differently and we will lose less.
However, some assets have a strong dependence on each other. For example, if tomorrow cobalt (a key material for electronic circuits) were to run out, it is very likely that both Apple and Google would suffer a sharp fall. Technology companies, food companies, energy companies, logistics companies, or any other category you can think of, tend to move in a similar way when they are affected by factors that affect the same sector.
So now the next question comes to mind,
How do we select assets to diversify our portfolio?
The mathematical answer is easy, through correlation.
In simple terms, correlation shows the degree of relationship between the assets; if it is positive, the two will behave similarly, and if it is negative, they will behave in completely opposite ways. The correlation can take values between -1 and 1, where -1 is a high negative correlation, 1 is a high positive correlation and 0 is that they are not correlated at all.
Let's look at some assumptions with hypothetical Apple and Google valuations.
If Apple and Google shares had little or no correlation, it would mean that if Apple's stock fell the probability that Google's stock would not fall or would fall much less than if they had a high correlation.
Correlation 0.2
However, if Apple and Google shares were highly correlated, if one were to fall, it would be very likely that the other would fall as well.
Correlation 0.8
Finally, if their correlation were high but negative, if one of them were to fall, the other would have a high probability of rising, since they are inversely related.
Correlation -0.8
As you have probably gathered, when two assets have a negative correlation or close to 0 correlation between them, it means that our investment in those assets gives us a good diversification advantage.
Does investing in cryptocurrencies help diversify my portfolio?
The next question many of you will have is whether cryptocurrencies are useful for diversifying a portfolio with "more traditional" investments.
In order to answer this question, we are going to conduct an analysis in which we compare the correlation between three popular indexes: IBEX 35, the DOW JONES (DJI) and EURO STOXX 50 with:
Gold: one of the most popular safe haven assets.
Oil: another of the most important assets.
Bitcoin: the most important cryptocurrency by capitalization.
Our StaticIndex product: based on an index algorithm of 10 cryptocurrencies selected by CryptoTechFin to which we apply our self-adjusting portfolio algorithms.
We are going to analyze which product will bring more diversification to each index investor based on correlation.
In the following graph we can see the evolution of asset prices in the period between March 2021 and December 2022.
These are the results of the correlation between these assets:
| IBEX 35 | DOW JONES | EUR STOXX 50 |
StaticIndex | 0.26 | 0.12 | 0.11 |
Bitcoin | 0.16 | 0.35 | 0.32 |
Oro | 0.47 | 0.28 | 0.30 |
Petróleo | 0.46 | 0.31 | 0.20 |
As we can see the two crypto products (mostly Bitcoin followed by our StaticIndex product) have much less correlation with the IBEX 35 than gold or oil, which means that they would diversify our investment more. However, in the case of the DJ index the products that offer the most diversification are StaticIndex followed by Gold, while for the EUR STOXX 50 the ranking is led by StaticIndex together with Oil.
However, it is important to keep in mind that diversification is only one of the factors to consider when investing. Other key factors are for example profitability or risk.
In the following articles we will analyze other factors that allow us to draw a better conclusion of the investment alternatives.
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NOTE 2: StaticIndex is only available to VIP clients due to its nature. If you are interested in more information, please contact us at soporte@cryptotechfin.com with the subject staticIndex.
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