Asset allocation
How do you decide how to split capital across assets, and what does a week of correlated falls show about that split?
In plain words
Asset allocation is how a pool of capital is divided between different assets — for example, a share in BTC, a share in ETH, and a share held in cash. The split is usually set before the week begins and determines how much each asset's rise or fall moves the whole portfolio.
Why it matters
Allocation is the main lever controlling overall risk. When two assets move in the same direction and closely together, holding both removes less risk than expected, and a heavy weight in either one dominates the result.
In a real week: BTC, week of 8 July 2019
In the week of 8 July 2019, BTC fell 10.83% and ETH fell 15.05 percentage points more, both in the same direction. BTC-ETH hourly correlation was 0.71, labelled close, and BTC's realised volatility was 101.8% a year. After three up weeks out of four, a portfolio split between the two was not protected from the fall, because both assets dropped together.
A common mistake
Assuming splitting capital between two assets removes risk. If the assets are closely correlated, the split changes the weights but not the direction of the overall loss.