The BGSV Portfolio

How might an investor construct a portfolio of very risky assets? To investigate, we consider:

• First, diversifying with monthly rebalancing of:
  1. Bitcoin Investment Trust (GBTC), representing a very long-term option on Bitcoins.
  2. VanEck Vectors Junior Gold Miners ETF (GDXJ), representing a very long-term option on gold.
  3. ProShares Short VIX Short-Term Futures (SVXY), to capture part of the U.S. stock market volatility risk premium by shorting short-term S&P 500 Index implied volatility (VIX) futures. SVXY has a change in investment objective at the end of February 2018 (see “Using SVXY to Capture the Volatility Risk Premium”).
• Second, capturing upside volatility and managing drawdown of this portfolio via gain-skimming to a cash position.

We assume equal initial allocations of $10,000 to each of the three risky assets. We execute a monthly skim as follows: (1) if the risky assets have month-end combined value less than combined initial allocations ($30,000), we rebalance to equal weights for next month; or, (2) if the risky assets have combined month-end value greater than combined initial allocations, we rebalance to initial allocations and move the excess permanently (skim) to cash. We conservatively assume monthly portfolio reformation frictions of 1% of month-end combined value of risky assets. We assume accrued skimmed cash earns the 3-month U.S. Treasury bill (T-bill) yield. Using monthly prices of GBTC, GDXJ and SVXY adjusted for splits and dividends and contemporaneous T-bill yield during May 2015 (limited by GBTC) through June 2019, we find that:

Pairwise correlations of monthly returns for GBTC-GDXJ, GDXJ-SVXY and GBTC-SVXY are 0.14, 0.09 and 0.01, respectively, over the sample period. These low correlations indicate substantial diversification potential.

The following chart tracks net cumulative value of the gold-Bitcoin-short volatility (BGSV) portfolio rebalanced monthly over the sample period with no excess cash skim. Notable points are:

• Growth is strong, with compound annual growth rate (CAGR) 36%, but is very inconsistent across subperiods.
• Performance is very volatile, with maximum drawdown (MaxDD) -64%. 

The sample period is very short for this test. Immaturity of crypto-assets and change in SVXY investment objective are confounding.

What happens when we implement the cash skim?

The next chart tracks cumulative value the portfolio with cash skim (BGSV Skimmed) and separately its accrued, skimmed cash component over the available sample period. Notable points are:

• Growth is still strong, with CAGR 25%, but is inconsistent across subperiods.
• The cash skim suppresses volatility, with MaxDD -29%.
• The large cash build-up suggests alternative uses for cash.

Again, the sample period is very short for this test.

In summary, very limited evidence suggests a possible way to exploit a collection of very risky but diversified assets via a cash skim.

Cautions regarding findings include:

• As noted, the sample period is very short and may not be representative of forward behaviors of the selected assets, particularly for GBTC. Results are sensitive to start date.
• GBTC generally carries a large premium relative to Bitcoin holdings. This premium may erode with introduction of similar, competing funds.
• SVXY is a financial instrument constructed from derivatives of a measurement for U.S. stock market expected volatility (not a real asset), dependent on the financial health of the offeror. As noted, the offeror changed SVXY investment objective during the sample period.
• Other groups of uncorrelated risky assets may or may not work as well.
• Precise rebalancing of small portfolios is problematic.
• Using some relatively low-risk asset other than cash for skimmed gains (appropriate to expected holding period) may improve performance.