By Matthew Edmer
The recent rise in cryptocurrency as an asset class has been amazing. The amazing returns have naturally led to increased demand from investors looking to access cryptocurrencies.
In short, a cryptocurrency is a digital currency that is generally not under the control of any central authority. Among these various cryptocurrencies, Bitcoin (BTC-USD) has been the dominant token with a market capitalization of around $900 billion, and currently accounts for nearly 40% of the global cryptocurrency market capitalization.
CME Group began offering bitcoin futures in late 2017 to take advantage of the increased demand for exposure. After nearly four years, we’ve now seen bitcoin futures make their way into ETFs and we’ve added them to our WisdomTree Enhanced Commodity Strategy Fund (GCC).
As part of our goal of continuous innovation and enhancement of our Managed Futures product, we allocated 1.5% exposure to Bitcoin futures in the WisdomTree Managed Futures Strategy Fund (WTMF) in early January 2022. WTMF will not invest in Bitcoin directly.
WTMF is a systematic trend-following strategy that provides exposure to equities, commodities, currencies and interest rates through positions in futures contracts in pursuit of positive aggregate returns in rising or falling markets that are not directly related to broad market equities or fixed income returns. We believe that the addition of Bitcoin futures not only differentiates WTMF from other managed futures ETFs but provides investors with exposure to Bitcoin in a risk-conscious manner.
Ultimately, we believe that what makes Bitcoin attractive to investors is the potential for significant absolute returns.
However, there are other features of Bitcoin that make it an attractive addition to our future managed product. Specifically, Bitcoin has historically been an excellent diversification tool from other traditional asset classes.
In the chart below, we show the correlation of the spot bitcoin price with other asset classes. We examine the correlation of the spot bitcoin price with other asset classes up to December 31, 2017, roughly the time that CME Bitcoin futures began trading.
Although spot returns can differ significantly from futures returns, we expect spot rates to provide a reasonable proxy for a forward month contract in Bitcoin when the correlation is examined.
We can see that during this period, bitcoin was poorly correlated with other asset classes.
We believe that the historically low correlation between Bitcoin futures and other asset classes bodes well for strengthening the risk-adjusted return profile of a multi-asset fund like WTMF. We made major adjustments to the WTMF in June 2021 with the goal of improving the risk-adjusted return, and it would be useful to examine the relationship between Bitcoin and the restructured fund. We already see that the spot bitcoin price has a weak correlation with the fund since the restructuring on June 4, 2021.
Exposure to WTMF Bitcoin futures is achieved through futures contracts traded on the Chicago Mercantile Exchange (CME). CME Bitcoin futures are now highly liquid, with an average 60-day daily volume (ADV) of around 7,700 as of November 30, 2021. Assuming the fund’s assets are $155 million, trading at a 3% allocation would be just 0.23% From 60 day ADV.
It is important to have a well-defined goal when designing a strategy. The astonishing rise in the price of Bitcoin in recent years is certainly cause for concern. However, caution should be exercised as Bitcoin has historically been very volatile. Our goal is simple: to provide investors with Bitcoin exposure through a systematic strategy designed to reduce volatility compared to a long-only strategy while capturing some of the upside potential that Bitcoin offers.
Due to the high historical Bitcoin volatility, at the moment we allocate only 3% token exposure to Bitcoin exposure. The goal here is for the Bitcoin component to contribute meaningfully but not control the volatility profile of the fund.
Since the WTMF is a structured trend-following fund, the Bitcoin strategy must also be able to dynamically adjust exposure depending on how strong the price trend is. To better protect against lengthy pullbacks, we use a momentum signal that reacts more quickly to up-to-date information. The 3% nominal amount we invest depends on how strong the trend signal is.
Finally, since Bitcoin has shown a long-term bullish tendency, at the moment we are restricting the model from taking short positions. Instead, we are simply allotted to cash. This is likely to reduce the volatility of the model. The long/flat pattern of the Bitcoin component is illustrated in the figure below.
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To rebalance for January, the fund will take a long position of 1.5% in Bitcoin futures (represented by the crypto sector in the chart above). It is worth noting that the fund remained net for a long time in most of the commodities, stocks and US dollar index sectors. The fund is also short price contracts.
As part of our goal of continually improving our managed futures product, WTMF is now the first systematically trend-following ETF providing investors with access to exposure to Bitcoin futures. The fund is currently long Bitcoin futures at 1.5% after rebalancing in January. We believe that adding exposure to Bitcoin futures has the potential to enhance the fund’s risk-adjusted return as well as further diversify the fund’s components. Our goal is to provide investors with this exposure in a risk-controlled manner via a regular long/steady trend-following strategy that reacts quickly to changing market conditions.
Important risks related to this substance
There are risks associated with investing including the potential loss of capital. Investing in this fund is speculative, involves a significant degree of risk, and should not constitute the investor’s entire portfolio. One of the risks associated with the fund is the complexity of the various factors that contribute to the fund’s performance, as well as its correlation (or unrelatedness) with other asset classes. These factors include the use of long and short positions in commodity futures, currency futures, swaps and other derivatives. Derivatives can be volatile, may be less liquid than other securities and more sensitive to the effects of diverse economic conditions.
In addition, bitcoin and bitcoin futures are a relatively new asset class. They are subject to unique and intrinsic risks and, historically, have been subject to significant price volatility. While the bitcoin futures market has grown exponentially since I started trading bitcoin futures, there can be no guarantee that this growth will continue. The price of bitcoin could drop sharply (including to zero), which is expected to have a similar effect on the price of bitcoin futures. The fund should not be used as a means of taking long (or only short) positions in commodities or currencies. The fund may lose significant value during periods when long indices only rise (or only short) fall.
The investment objective of the fund is based on historical price trends. There can be no guarantee that such trends will be reflected in future market movements. The fund generally does not make adjustments during the month and is therefore subject to significant losses if the market moves against the fund’s fixed positions on a monthly basis. In markets where there are no established price trends or markets that quickly reverse or “flip”, the fund may incur significant losses. The fund is managed effectively and therefore the fund’s ability to achieve its objectives will depend on the effectiveness of the portfolio manager. Due to the investment strategy of this fund, it may distribute higher capital gains than other ETFs. Please read the fund’s prospectus for specific details related to the fund’s risk profile.
Matthew Edmer, Research Analyst
Matt Aydemir began his career at WisdomTree as a Research Analyst in January 2020. He is responsible for quantitative research on WisdomTree products, as well as maintenance and reconfiguration of WisdomTree indexes. Prior to joining WisdomTree full time, Matt worked on the research team as an intern, developing tools for portfolio analytics. Matt earned a master’s degree in financial engineering from Columbia University in 2020, and a bachelor’s degree in chemical engineering from the University of Waterloo in 2016.
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