Diversification Benefits of Commodities for Cryptoasset Portfolios

Abstract

The aim for balance between risk and reward in investment portfolios often requires studying the diversification contribution of its constituents. This objective requires to specify whether investors can extend their exposure in certain asset classes and benefit their portfolios in a statistically significant way. In this paper, we address this issue of diversification in the context of cryptoasset portfolios and examine whether their risk-adjusted performance can be enhanced through seeking exposure into the commodities class. For an equally-weighted portfolio of five cryptoassets, we first consider the addition of physical gold, as conceptualised by the CoinShares Gold and Cryptoassets Index, a diversified, monthly-rebalanced index that seeks exposure to both asset classes. We further consider modifying the index composition by replacing physical gold with a basket of five commodities. Mean-variance spanning tests reveal that the addition of physical gold in the original cryptoasset portfolio translates to a significant shift in the efficient frontier, both in terms of the global minimum variance and the tangency portfolios. Additionally, expanding the exposure in the commodity side confirms a statistically significant improvement, with the diversification benefit arising from a shift in the tangency portfolio. We further generate a number of price paths for the original index, the modified index and their components, according to a Dynamic Conditional Correlation GARCH specification, to assess the efficiency of the index weighted risk contribution scheme. Results demonstrate a superior performance of the two indices when compared against their constituents in terms of Omega ratio. The modified index appears more appropriate for investors that seek higher annual returns, while the original composition would be more appropriate for individuals with moderate annual return goals.