13 minute read
Managers
HOW HEDGE FUNDS ARE TAPPING INTO A WEALTH OF CRYPTO OPPORTUNITIES
While the volatile nature of cryptocurrencies – coupled with the still-unfolding shape of regulation – has kept some investors on the sidelines, outsized returns offered by digital assets continue to draw in hedge fund managers
Along with a slew of smaller, crypto-native managers, there’s a growing list of established, brand-name firms from both sides of the Atlantic stepping into the space.
Among the eye-catching roll-call of hedge fund heavyweights is Brevan Howard Asset Management, which last year expanded its focus both with the launch of BH Digital, a new division dedicated to managing cryptocurrency and digital assets, and through its Brevan Howard Master Fund, which opened to crypto assets in May 2021 also saw US hedge fund veteran and longstanding digital assets evangelist Bill Miller’s long-running flagship fund move into the market.
Paul Tudor-Jones, the macrofocused founder of Tudor Investment Corp, and former Fortress Investment Group manager Michael Novogratz, who now runs cryptocurrencyfocused asset manager Galaxy Investment Partners, are also long-standing crypto advocates advocates, along with other highprofile industry veterans including Stanley Druckenmiller, Ray Dalio, and Anthony Scaramucci.
Exposure
Last year’s third annual ‘Global Crypto Hedge Fund Report 2021’, published jointly by PwC, Elwood Asset Management and the Alternative Investment Management Association, found roughly 150-200 active crypto hedge funds, with four out of five (81 per cent) launched between 2017 and 2020, spread across a range of discretionary longonly, discretionary long/short, multistrategy and quantitative investment strategies.
One in five (21 per cent) of traditional hedge fund managers also actively invest in digital assets, according to the data, with the average percentage of their total hedge fund AUM invested standing at 3 per cent.
WHAT’S YOUR STRATEGY?
“We are thematic long/short – that’s our core portfolio. Outside that, we trade a whole range of market neutral, derivative-type opportunities that surface from time to time. We describe ourselves as ‘quantamental’ – we have a fundamental team and then we have a quantitative team. We talked to our investors and asked them whether they wanted us to be pretty safe in crypto-land, or if they were looking to us for a real performance diversifier. They all, without exception, said they wanted us to go after a minimum of 35 per cent a year. That’s what they’re looking for. My view is that there is a risk/return threshold for investing in crypto. It’s very different from just looking at what the basis is between futures and spot and trading it for three months and coming out on the right side. Given the spreads that are charged by exchanges, given the inherent costs in the market, given the custody issues, I think you have to be making 30 per cent plus to be credible. If you’re not doing that, then investors who are putting money with you may be better off in a traditional hedge fund, probably because they don’t carry some of those fundamental risks which are inherent in the crypto markets.”
WHAT’S YOUR STRATEGY?
SAMED BOUAYNAYA, RISK OFFICER AND DIRECTOR OF ALTANA UCITS FUNDS, ALTANA WEALTH
“Altana Wealth launched its Digital Currency Fund in 2014, mainly investing in the top four market-cap cryptocurrencies, primarily bitcoin and Ethereum. It was actively managing the three or four major assets, taking gains and reinvesting at certain levels which proved to be more successful than simply following bitcoin. From that we have evolved, and our new strategy considers blockchain technology as a whole. Bitcoin dominance has shifted from 90 per cent to below 40 per cent, and that gives validation to an entire ecosystem of cryptocurrencies that are eating into the top market cap we had previously in 2017 and 2018. We want to be in this space in order to capture this market share shift to new Layer 1s and new protocols. Our new investment strategy is a discretionary fund that will invest in blockchain technology across six different themes using a top-down approach with a strict VC-style investment. We have due diligence that we apply to each protocol prior to investing in it, and we complement this with narrative and sentiment analysis.” We will invest in early-stage tokens and listed liquid tokens. The early stage tokens will typically be via private placements or liquidity pools, while the listed tokens will be typically blue-chip projects we believe will withstand the future bear cycles. We will also be nimble, we won’t be married to our positions and we will evolve as narratives evolve, but at the same time we will give our blue-chips enough time to realise their market adoption and their full market potential.”
Lee Robinson, founder and CIO of multi-asset class manager Altana Wealth – a prime mover in the crypto hedge fund landscape which entered the sector in 2014 with its Altana Digital Currency Fund – says several things changed in late 2020 and early 2021 which ultimately helped make the asset class respectable in the eyes of previously-reticent players.
“One was the realisation among people that they needed to have an exposure to crypto – whether it was DeFi, bitcoin, VC; be it one per cent, be it two per cent, be it half a per cent. That was a big change,” says Robinson, whose firm is preparing to launch a new digital assets strategy focused on blockchain opportunities.
The other was banks and other payment companies such as MasterCard and PayPal offering crypto services for their customers. “It meant a whole new swathe of institutions could come into crypto. At nearly USD3 trillion, and one per cent of global assets, it can no longer be ignored by large institutions. That’s the reality,” adds Robinson, who before launching Altana in 2010 had been CIO and co-founder of event driven specialist hedge fund Trafalgar Asset Managers and, earlier, a portfolio manager at Tudor Investments.
Volatile
Despite crypto hedge fund strategies scoring stellar returns in recent seasons – HFR’s 2021 year-end data shows digital assets managers outflanked all other hedge fund strategies – the difficulty of having a profitable strategy in such a volatile market should not be underestimated, according to Paul Frost-Smith, founder and CEO of London-based Corinthian Digital Asset Management, a thematic, relative value digital assets hedge fund.
“Unless you’ve got people who really know what they’re doing in derivatives, I think this is a very difficult market to have a strategy that can work,” Frost-Smith tells Hedgeweek. “This market moves around a lot. You have implied volatility between 80 and 120; by comparison, when I was in equity derivatives, the highest I think we ever saw for any significant length of time was 42ish.”
In a market commentary last year, London-headquartered publiclytrade hedge fund giant Man Group indicated bitcoin’s volatile price movements could be seen as part of the price discovery process in a new assets, which will ultimately give way to greater stability in the currency and, crucially, more credibility in the eyes of investors.
Frost-Smith says: “Correlations are highly complex in this market, much more so than in the equities or bond markets, and so you really have to have some idea of correlation and hedging ability to run a profitable strategy. Essentially you’re looking at a much more quantitative-type market than traditional markets and that provides the biggest barrier to entry to the day trader.
“There are things that are hard to explain in the market – recently we saw a 9 per cent drop in bitcoin overnight. If you look at some of the altcoins, they are down 14, 18, 22 per cent. So there are inexplicable,
underperforming aspects of the market which we are constantly looking into, constantly crunching data on – another one of our big spends is on data and having our quants crunching huge amounts of data.”
Managers also point to the 24/7/365 nature of the crypto market, which offers a wealth of crossexchange arbitrage opportunities for systematic funds, but can be a tricky step-change for some investment firms used to trading traditional hedge fund strategies such as long/short equity, macro or CTAs.
“It’s a different mindset,” says Lee Robinson. “You need to have that ability and that recognition that there’s no open and there’s no close. It’s a very different market, and for a lot of people, it’s very difficult to trade.”
Learning curve
Anatoly Crachilov, founding partner and CEO at London-based Nickel Digital Asset Management, also reflects on the culture gap between digital-first, crypto-native managers and those established traditional funds looking to enter the digital assets sphere.
“There is a commitment and passion across this group of people who are now creating and building a new generation of hedge funds in crypto. But for traditional hedge funds, it’s a jump – they have to change many of the ways they have been operating on the tech level and also hire a new generation of people. It’s not always an easy transition,” Crachilov tells Hedgeweek.
Launched in early 2019 with its flagship Digital Asset Arbitrage Fund, Nickel Digital aims to bridge the gap between traditional finance and the cryptocurrency market, offering a diverse range of investment strategies across the hedge fund, multi-strategy and long-only spectrum.
Crachilov says: “There is a cultural adoption which is required here – you need to have onboard people who are pro-crypto, if you will, who are willing to engage and put themselves on this massive learning curve, because crypto is a fast-moving animal.”
Looking ahead, Lee Robinson suggests the future generation of leading hedge fund traders and algorithm programmers are those who are cutting their teeth in crypto.
“We all used to hire people out of banks. But the next wave of new traders, who are currently 16 through 22 and who you want to hire when they are 25-35, you’re going to find them in this space, regardless of whether you like this space or not,” he explains. “If you’re recruiting people who you want to be programming and doing quant trading or algo trading, you’re not going to find them very easily if you ignore the crypto space. It’s where all the talent is coming through globally.”
WHAT’S YOUR STRATEGY?
KEVIN KANG, FOUNDING PRINCIPAL, BKCOIN CAPITAL
“It’s important for us to be able to offer investors different strategies that fit with their risk appetite profile. We’re launching a multi-strategy fund this year which is going to still have a market neutral focus, but it’s going to have a combination of directional components – momentum, mean reversion, and trend-following – overlaid with options. So not only will we be able to take advantage of all this mispricing in the market, but we’ll be able take advantage of some of the volatility that comes with the crypto space. We’re also launching a DeFi fund as well as a VC fund. We’re really pivoting ourselves to become a go-to active manager in this space, and be able to offer all different types of flavors, whether it be VC, or an actively managed market neutral strategy, or to take advantage of the opportunities that DeFi offers. We’ll be able to offer different types of strategies to different types of investors.”
CRYPTO POSSIBILITIES PIQUE INSTITUTIONAL INVESTOR INTEREST
Until recently retail investors were at the forefront of digital asset investments. Since the pandemic, all types of investors, notably institutional investors who were somewhat initially reluctant, are steadily realising the potential of investing in cryptocurrency
Despite various concerns around the asset class, a study commissioned by Nickel Digital Asset Management has revealed that, since the start of the pandemic, institutional investors and wealth managers have changed their opinion on cryptocurrency, with 43 per cent saying that they now have a much more positive outlook on the asset class, citing reasons such as strong capital growth, clearer diversification benefits, and improving custodial services.
More specifically, the study revealed that 78 per cent have a positive opinion of bitcoin, with only 9 per cent saying that their perception of it is negative, and for Ethereum, 77 per cent have a positive view with only 7 per cent considering it a negative investment.
“We’ve seen investor interest increase dramatically, particularly over the past year, with total value locked in the DeFi market already reaching USD250 billion at the start of this year, from just USD18.7 billion in January 2021,” says Diana Biggs, chief strategy officer, DeFi Technologies.
Close to innovation
Investment consultant Syz Capital has also noticed an increasing interest in digital assets from investors. Sherban Tautu, head of liquid alternatives, says: “Our clients are very interested in crypto, NFTs and blockchain infrastructure. They wish to invest in digital assets as a way of being exposed to innovation assets. They’ve seen the interest from the younger generation and wish to learn more about it.”
Chris Shelby, director, private markets at Verus, also notes a high interest in bitcoin, other cryptocurrency, and related strategies.
A recent study carried out by investment platform VALK showed how professional investors are also increasingly focusing on digital assets, with roughly a third – from a pool of professional investors working in eight major economies for institutions holding more than USD1 trillion AuM – recently investing in crypto assets for the first time, and 55 per cent increasing their allocations.
This burgeoning interest within the investor community is also reflected in findings from a recent industry poll of more than 50 “The long-term trends for crypto continue to be positive; institutional investors continue to invest in the space and are more willing to use these new platforms. Just like other asset classes, there will be ups and downs in the short-term, especially since crypto is a complete rewrite of the traditional financial system. While price drops may affect investor sentiment, they have never slowed down the pace of innovation in the space.”
George Melika, co-founder and CEO, San Francisco Open Exchange “
No 61% Yes 39%
Source: Hedgeweek readers survey, January 2022
hedge fund managers conducted by Hedgeweek, which suggested around 39 per cent of managers have been asked by allocators to offer a digital assets vehicle.
Fringe experiments
Whereas ESG was a concern at the forefront of the industry this time last year, the VALK study shows that 54 per cent of professional investors are now more concerned about custodial services in DeFi and 52 per cent are also concerned about security issues.
Jawad Nayyar, co-founder and CVO, DAO PropTech says: “Apart from the volatility, issues of legality and security still plague the space making it difficult to do anything other than experiment on the fringes with crypto.”
Investors are calling for the regulatory environment to improve, with VALK’s research showing that 84 per cent expect regulatory improvements over the next three years, and 12 per cent predict a dramatic improvement.
To combat this and still allow for some allocation, John Bowman, executive vice-president, CAIA Association, thinks investors “should be taking a diversified “venture” approach to expose and play in this very disruptive and volatile innovation petri dish.”
Made with
The burgeoning support and interest among institutional investors throughout 2021 and into 2022 suggests digital assets are now being taken more seriously by managers and are starting to be viewed as a viable asset class, due to the high returns and investment opportunities.
Biggs adds: “As a relatively new alternative asset class, it naturally requires the right approach, timeframe, allocation and overall risk management, but the possibilities are definitely there for it to be a successful part of a diversified investment strategy.”
