The Bitcoin Barbell ETF Portfolio

I'm a firm believer in the investment strategy that shies away from the conventional "middle ground" or "balanced" approach—this is precisely why I'm not a fan of intermediate maturity bonds, the traditional 60/40 portfolios, or equal-weighted ETFs.

This concept isn't something I dreamed up on my own; it's heavily influenced by Nassim Nicholas Taleb, a renowned scholar, statistician, former trader, and risk analyst, best known for his work on probability and uncertainty.

Taleb is the author of influential books like The Black Swan among others, which explore the impact of highly improbable events and how to manage risk in a complex world.

While I highly recommend diving into his books for a deeper understanding, I won't spoil them here. Instead, I'll share one of his pivotal concepts—the barbell strategy—and show how you can apply it to your investment portfolio using specific ETFs.

What is the barbell strategy?

Taleb's barbell strategy involves balancing a portfolio between extremes—highly safe assets on one end and highly risky assets on the other, deliberately avoiding the "middle ground."

Taleb argues that this middle ground is actually the riskiest area to invest because it neither offers the safety of low-risk investments nor the significant upside of high-risk ones.

In practical terms, this might look like allocating 90% of your investment capital to risk-free assets, while the remaining 10% would be invested in "moonshots"—speculative bets that could either fail or deliver disproportionately high returns.

This setup caps your maximum potential loss at a manageable level (the 10% allocated to risky investments) while leaving your potential for gains theoretically unlimited if one of those high-risk bets pays off significantly.

Risk-free ETFs to use

For the risk-free 90% of our barbell portfolio, I recommend using Treasury Bill (T-bill) ETFs. T-bills are considered virtually risk-free in terms of both interest rate and credit risk, making them ideal for the conservative side of a barbell strategy.

Additionally, with current interest rates at relatively high levels, you can expect to earn a yield of over 5% from these investments, which is quite attractive.

There are several cost-effective ETF options available that focus on T-bills, many of which offer the convenience of monthly distributions. Here are some solid choices:

• SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
• iShares 0-3 Month Treasury Bond ETF (SGOV)
• Global X 1-3 Month T-Bill ETF (CLIP)
• US Treasury 3 Month Bill ETF (TBIL)

Risky ETFs to use

For the risky portion of our barbell portfolio, we're looking for assets that can "melt up." This term refers to assets that have the potential for explosive growth in value, typically during market conditions that favor high-risk investments.

Additionally, it's crucial that these assets do not have "negative carry," which means they shouldn't cost money to maintain, unlike traditional insurance or hedging products that require premiums and generally lead to capital depletion over time if no catastrophic events occur.

This criteria effectively rules out options such as put options and short-term VIX futures. While these assets offer convexity—meaning their value could increase exponentially during market downturns—they inherently involve costs that can continuously drain your capital until the rare, catastrophic market event happens.

An unconventional but fitting choice for this high-risk component is Bitcoin. Although Bitcoin tends to perform poorly during market crashes, this is not a concern since 90% of our portfolio is safeguarded in T-bills.

Conversely, during favorable conditions, Bitcoin has demonstrated the potential for massive, triple-digit returns within a single calendar year, showcasing its significant upside.

As of January 11, U.S. investors have the convenience of accessing Bitcoin through several ETFs, making it easier to rebalance against T-bill ETFs within any brokerage account. Here are some of the top Bitcoin ETFs currently available:

• Bitwise Bitcoin ETF (BITB)
• ARK 21Shares Bitcoin ETF (ARKB)
• Fidelity Wise Origin Bitcoin Fund (FBTC)
• Invesco Galaxy Bitcoin ETF (BTCO)
• VanEck Bitcoin Trust (HODL)
• The Valkyrie Bitcoin Fund (BRRR)
• Franklin Bitcoin ETF (EZBC)
• WisdomTree Bitcoin Fund (BTCW)
• Hashdex Bitcoin ETF (DEFI)

Putting it together

Let's consider how a barbell portfolio, with 10% allocated to spot Bitcoin and 90% to T-bills, would have performed from 2015 to the present, compared to the S&P 500, with quarterly rebalancing.

The results are intriguing. This barbell strategy achieved a Compound Annual Growth Rate (CAGR) of 12.31%, slightly lower than the S&P 500's 12.80%.

However, the more telling numbers are in the risk metrics. The standard deviation, a measure of volatility, was significantly lower for the Bitcoin barbell portfolio at 8.92% compared to the S&P 500's 15.51%.

Furthermore, the maximum drawdown, which indicates the largest drop from peak to trough, was much smaller at 8.9% for the barbell portfolio versus 23.93% for the S&P 500.

This resulted in a Sharpe ratio—an indicator of risk-adjusted return—of 1.17 for the Bitcoin barbell, substantially higher than the S&P 500's 0.75.

The implications here are significant. The 90% allocation to T-bills effectively mitigated risk by providing a stable, low-volatility buffer against the market's fluctuations.

Meanwhile, during particularly strong years for Bitcoin, the cryptocurrency's stellar performance significantly boosted the overall returns of the portfolio, resulting in superior risk-adjusted returns compared to a traditional market index like the S&P 500.

This demonstrates how a strategically structured barbell portfolio can leverage the explosive potential of high-risk assets while maintaining a foundation of stability to manage downside risk effectively.