In this article, Tommaso Mancuso, President & CIO at 3iQ, shares his insights on the role of convexity in a portfolio.
The 60/40 portfolio had its worst year in half a century in 2022. Bonds fell 13%, equities 18%, and the two assets meant to hedge each other instead sold off together. Three years later, most institutional portfolios responded by adding more diversifiers – more geographies, managers, sleeves, and illiquid alternatives. It hasn’t worked, and the evidence suggests it won’t.
For decades, diversification was the free lunch of portfolio construction. But the regime that made it free (disinflation, falling rates, and negative stock–bond correlation) has ended. Today’s environment of fiscal dominance, sticky inflation and geopolitical fragmentation pushes correlations up precisely when investors need them down. In this world, resilience comes not from more diversification but from convexity – and the most cost‑effective source of convexity available to institutions today is digital assets, accessed through the right vehicle.
Why Diversification Has Stopped Paying
Two problems undermine the “add more sleeves” reflex.
First, correlation regime change. Negative stock–bond correlation was a feature of a specific monetary era, not a permanent law. When inflation is the dominant macro risk, stocks and bonds tend to fall together because both are discounted by rising real yields. 2022 was not an anomaly; it was the new regime announcing itself. Investors who rebuilt the same portfolios have been disappointed ever since.
Second, diminishing returns to incremental diversification. Adding a twelfth equity sleeve or fifth private credit manager does not meaningfully reduce risk. Most alternatives are structurally beta in disguise: private equity behaves like public equity with illiquidity smoothing, emerging market beta rises in stress, hedge fund composites have delivered low returns with rising correlations.
Calendar returns make the point clearly. Global bonds (the supposed diversifier of last resort) delivered a negative compound return from 2021 to 2025 and failed in multiple stress years. The hedge stopped hedging.
What Convexity Is – and Isn’t
Convexity is a return profile where upside participation materially exceeds downside capture. The portfolio accelerates when it makes money and slows when it loses money. It is not a risk premium or a return driver, it is a shape.
Traditional assets print negative skew and up/down volatility ratios below one: fat left tails and more variance absorbed on the way down than captured on the way up. Digital assets and the active strategies built on them show the opposite signature: positive skew and materially higher up/down volatility ratios.
Why Convexity Is Expensive Everywhere Else
Allocators want convexity, but in efficient markets it is priced high.
- Long‑volatility strategies bleed premium during calm regimes, which last longer than crises.
- CTAs and trend‑followers offer convexity over long arcs but suffer extended drawdowns that committees struggle to hold through.
- Tail‑risk funds function as insurance, and insurance premiums compound against the portfolio in every non‑tail year.
These products are not flawed, they are simply priced efficiently. Convexity becomes a tax.
Why Digital Assets Offer Convexity Cheaply
Digital assets offer convexity cheaply because the market is still under‑owned, volatile and structurally inefficient. At ~$2.7 trillion, the asset class is large enough to be investable but small enough to remain inefficient. Bitcoin’s high volatility (historically a deterrent) becomes attractive when paired with positive convexity. A 3% allocation can contribute 30–40% of a portfolio’s asymmetry.
Market inefficiencies are real: fragmented liquidity, shallow research coverage, heterogeneous flows, and exchange‑linked derivatives risks. Skilled active managers can extract meaningful asymmetry through positioning, risk sizing and drawdown control – without paying the option premium required in efficient markets. Digital hedge fund indices show roughly twice the skew and up/down volatility ratio of the underlying market.
The Vehicle Determines Whether You Can Hold the Position
Spot exposure gives you the asset but not necessarily a holdable institutional position. A 2% spot allocation can swing to 1% or 4% within quarters. For risk‑constrained allocators, actively managed strategies (long‑biased or market‑neutral) may be more viable.
A properly risk‑architected digital strategy can deliver cycle returns similar to the underlying asset at roughly one‑third the volatility and drawdown. That allows an institution comfortable with 2% in spot to hold 4% in convex form and capture twice the dollar return at similar risk. The asset is the same; the product is not.
This sleeve belongs in alternatives as a dedicated convexity allocation, sized by risk contribution rather than capital weight.
The Window Is Open, But Narrowing
The inefficiency enabling cheap convexity will erode as institutional capital scales, just as hedge fund alpha compressed from the 1990s onward. Crypto hedge funds still deliver double‑digit returns with little or no leverage, while traditional hedge funds require multiple turns of leverage for single‑digit returns.
Institutional adoption has begun: AIMCo, Mubadala, Norges Bank, Capital Group and UBS have all increased digital asset exposure. Beta adoption is underway; alpha adoption is next. The window likely remains open for several years but narrows with each quarter.
Engaging the Objections
“Crypto is too volatile.”
Volatility is raw material. What matters is the structure built around it. A positively skewed 20–25% volatility return stream producing 30–50% cycle returns is a Sharpe profile most equity products would envy.
“We already have convexity through equities, EM or private markets.”
These are return drivers, not convex exposures. Their skew is negative and their downside is tied to global beta.
“What about FTX, custody and regulation?”
The 2022–2024 period forced an institutional cleanup. Today’s infrastructure – regulated managers, segregated qualified custody, audited counterparties, ETF wrappers and clearer regulatory regimes – is materially different.
Conclusion
Diversification is no longer delivering resilience. Convexity is. Digital assets offer the cheapest convexity available to institutional investors — for now. The window is open, but it will not stay open forever.
Disclaimer
This publication is provided for educational and informational purposes only. It does not constitute financial, investment, legal, accounting, tax, or other professional advice, and must not be relied upon as such. Nothing in this publication is intended to recommend or promote any particular product, strategy, portfolio approach, issuer, digital asset, or service offering. Readers should not interpret any discussion of specific cryptocurrencies and other digital assets, markets, or strategies as a solicitation, offer, or endorsement. The views expressed were prepared for the purpose of providing readers with general educational background information about cryptoassets and are not appropriate for other purposes. 3iQ assumes no obligation to update or revise this document to reflect new events or circumstances.
The views and examples presented are general in nature and may not be appropriate for any specific investor, client situation, or regulatory context. Readers remain solely responsible for performing their own due diligence and verifying the accuracy of any information used in their decision-making.
Cryptocurrencies and other digital assets are highly volatile, may experience significant price fluctuations, and may not be suitable for all investors. 3iQ makes no representation or warranty as to the accuracy, completeness, or timeliness of any information contained herein. All content is provided on an “as-is” basis without warranty of any kind. 3iQ shall not be liable for any loss, damage, or adverse outcome arising from the use of, or reliance on, this material.
These materials do not constitute an offer to sell or issue or the solicitation of an offer to buy or subscribe for securities in the United States or any other jurisdiction.
