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How hedge funds are tapping into a wealth of crypto opportunities

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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.

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 long-standing digital assets evangelist Bill Miller’s long-running flagship fund move into the market.

Paul Tudor-Jones, the macro-focused founder of Tudor Investment Corp, and former Fortress Investment Group manager Michael Novogratz, who now runs cryptocurrency-focused asset manager Galaxy Investment Partners, are also long-standing crypto advocates advocates, along with other high-profile 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 long-only, discretionary long/short, multi-strategy 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.

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 publicly-trade 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 cross-exchange 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.”


Read the full Institutionalising Digital Assets: Powering the hedge fund crypto surge Insight Report here.

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