Charles-Henry Monchau

Chief Investment Officer

The first quarter of 2023 ended on a relatively positive note for risky assets, with the S&P 500 index up around 7%. However, after the setbacks of several US banks and Credit Suisse, the fear of another "black swan" is dominating investor sentiment. Indeed, the latest Bank of America survey of fund managers shows that a systemic credit event is now considered by investors as the most important tail risk, replacing de facto the risk of inflation remaining high over time. 

Systemic credit event overtakes inflation stays high as biggest tail risk


Source: BofA Global Fund Manager Survey

How can investors protect their portfolios against this type of event (called "tail risk")? 

In a world of low inflation or even deflation, the combination of equity and bond pockets in a portfolio was a winning formula. Indeed, the correlation between stocks and bonds proved to be negative most of the time. When stocks performed poorly, bonds performed well and vice versa. Their offsetting performance allowed investors to build less volatile portfolios, better manage market declines and improve risk-adjusted returns.

But with the return of inflation, we are now in a new paradigm. Equity and bond markets tend to move in the same direction (see chart below showing the correlation between the two asset classes over 24 months). In this context, government bonds are no longer fulfilling their role of portfolio protection. Should investors consider other asset classes to diversify portfolios? 

Bonds don't hedge equities in an inflationary world

Rolling 24 month correlation between stocks and bonds


Source: BofA research Investment Committee, Global Financial Data

Anti-fragile assets

While illiquid assets (venture capital, infrastructure, private debt, hedge funds, etc.) can be considered as a solution to improve the risk/return trade-off, many investors want to keep their portfolios liquid. In this case, they can seek de-correlation by including so-called "anti-fragile" assets in the portfolios. 

"Anti-fragility" is a concept that was developed in 2013 by Nassim Nicholas Taleb, the author of the best-selling book, The Black Swan. The thesis developed is that the opposite of fragile is not solid or robust, as one might intuitively think, but "antifragile." Fragile is anything that does not stand up to the test. Solid is everything that resists numerous tests. Antifragile is anything that gets better with testing. The concept applies to everything: politics, health, education, economics, urban planning... and, of course, the markets. In finance, the anti-fragile likes volatility, uncertainty, shocks, financial crises, etc.



"Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk, and uncertainty. Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile." - Nassim Taleb.



Gold, the king of anti-fragile assets?

In his book, Taleb did not comment on the case of gold as an anti-fragile asset. However, Stöferle and Valek, analysts at Incrementum and followers of the Austrian school, have addressed the issue. In their view, gold is neither particularly fragile, nor completely robust or anti-fragile. Its value lies in its trustworthiness, a prerequisite for any form of money. Gold has always been recognized as a medium of exchange and as a safe haven currency in times of crisis: "Gold is not a perfectly anti-fragile asset, but has, during severe crises, exhibited anti-fragile characteristics." 

The analysts from Incrementum highlight some of gold's robustness (not anti-fragility) characteristics: it is inherently stable/durable: it is known to be resistant to air, water, fire, and chemical attack; there is a stable supply of it; it is expensive and slow to mine.  In this sense, gold is robust. Gold is also one of the most liquid assets in the world in terms of the volumes in which it is traded, which helps to make it robust, even in times of stress. 

The value placed on gold is subject to wide price fluctuations. The gold market is manipulated and can be subject to speculation. As a result, the gold market is not immune to bubbles, so the price of gold tends to be fragile.

With no maturity risk and no counterparty risk, gold is the "anti-debt" asset by excellence. But "debt always weakens economic systems", as Taleb says. Furthermore, "the long-term trend in the price of gold is not related to the history of gold, but rather to the history of the monetary system. The long-term upward trend in the price of gold is the result of the monetary system's addiction to inflation." In this regard, gold is "clearly anti-fragile." 

One important caveat is that there is a threat of a ban on holding gold, particularly in the form of "restrictions and taxation of gold trading that would diminish the benefits of holding gold".

Stöferle and Valek conclude that gold has a place in an "anti-fragile portfolio," that is, a portfolio built on the principle that "a number of elements within the system must be fragile in order to make the system anti-fragile."

What about the behavior of gold in the recent past? In recent weeks, the price of gold has risen sharply following the collapse of several U.S. regional banks, the collapse of Credit Suisse and the growing risks of banking instability in Europe. Investors have been investing in the ultimate “safe haven”: gold. They may continue to do so if the banking crisis persists. 

Bitcoin, the new anti-fragile asset?

Bitcoin is often referred to as "digital gold". Indeed, its time-limited supply is one of its main similarities to precious metals. The "white paper" published before its launch in 2009 stated that Bitcoin production would be capped at 21 million by 2140. Today, 90% of the tokens have already been mined. It is estimated that there are less than 0.4 Bitcoins per millionaires on the planet. This ratio is expected to decline, as the number of millionaires grows faster than the number of Bitcoins in circulation. The process of introducing new bitcoins into the economy is therefore the opposite of fiat currencies, for which an unlimited amount of bills are currently being printed. Bitcoin is now scarcer than gold and has a deflationary tendency that will take it from a supply growth of 1.8% to 0.9% in four years and only 0.4% in the following four years.

Bitcoin emerged at a time when one of the biggest black swans hit the U.S. and global economy: the great financial crisis of 2008. Since its launch, bitcoin's monetary policy has made it the most robust and scarce currency on the planet. 

Bitcoin has survived many mistakes, shocks and even so-called "hard forks." Bitcoin has been declared dead many times. Bitcoin mining has been banned in several countries, causing huge mining farms to be shut down immediately without any consequences for the Bitcoin network. 

All these events and attacks did not stop the development and adoption of bitcoin. The cryptocurrency keeps getting stronger with every block deposited. Every 10 minutes, the security of all transactions made on previous blocks is strengthened. During each four-year period between halvings, the value of bitcoin has increased. 


It is this ability to survive and strengthen during crises that makes bitcoin an anti-fragile asset. Admittedly, its high correlation with stocks and bonds in 2022 has undermined bitcoin's anti-fragile nature. But this behavior should be seen in the context of bitcoin's exponential rise between 2020 and late 2021. The de-risking of 2022 penalized almost all financial assets and especially those that had appreciated strongly. 

In 2023, the price of bitcoin appreciated dramatically during the banking crisis in the US and following the Credit Suisse debacle. In the first quarter, bitcoin appreciated by 70%.



While the de-correlation properties of gold are accepted by most investors, the case of bitcoin is much more controversial. Yet the historical data is unequivocal. As the chart below shows, adding a 5% allocation to bitcoin in a 60-40 portfolio would have improved the risk-return trade-off, regardless of the period considered. Due to the high volatility of bitcoin, a small allocation or investment in a fund of hedge funds dedicated to digital assets may be appropriate in the current macroeconomic environment.

Adding Bitcoin to a 60/40 portfolio improves risk adjusted returns


NB: In blue the efficient frontier consisting of global stocks and bonds since 2015. In green, 60/40 portfolios (stocks/bonds) over different time periods. In red, a 60/40 portfolio with a 5% allocation to bitcoin (implying an equivalent reduction in the weight allocated to stocks and bonds). 


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