When bitcoin hit an all-time high of some USD20,000 earlier this month, it rounded off a remarkable year for the world’s leading cryptocurrency – and fully underlined the arrival of the once-niche asset class on a rapidly-growing number of hedge fund firms’ radars.
When bitcoin hit an all-time high of some USD20,000 earlier this month, it rounded off a remarkable year for the world’s leading cryptocurrency – and fully underlined the arrival of the once-niche asset class on a rapidly-growing number of hedge fund firms’ radars.
Several factors have fuelled this year’s digital currency surge – from the shifting macroeconomic backdrop since the Q1 coronavirus crash to an investor community gradually becoming more comfortable with cryptocurrency’s infrastructure.
The low-to-negative interest rate environment has led many allocators to see bitcoin – which has soared some 170 per cent this year – almost as a ‘gold version 2.0’ proxy, in contrast with overpriced equities.
“Since Covid-19, there has been a huge amount of money printing by central banks, which has flagged up macro implications, and that has very much brought the ‘digital gold’ narrative of bitcoin to the fore – not just within the crypto space but to the mainstream,” says Peter Habermacher, CEO at London-based Aaro Capital, a digital ledger technology, blockchain and cryptoasset multi-manager specialist.
Gaining momentum
After falling sharply at the end of March this year amid the coronavirus-fuelled market crash, bitcoin has rallied over the course of 2020, hitting record levels at the start of December.
The bitcoin ‘halving’ event in May – an event which takes place roughly every four years, in which the new supply of bitcoin is halved, leading to a block reward fall from 12.5 to 6.25 bitcoins – proved pivotal.
The currency’s path contrasts sharply with central bank quantitative easing amid the coronavirus crisis, observes Habermacher, who co-manages the Aaro DLT Multifund.
“One is inflationary, while the other is becoming deflationary,” Habermacher tells Hedgeweek. “We don’t think the halving story has fully played out yet, and that has the potential to drive bitcoin higher into next year.”
There are now more than 800 active blockchain and cryptoasset-focused funds, 150 of which manage more than USD50 million in assets. Overall, the sector has a market cap of around USD500 billion across digital currencies, with more than USD100 billion traded daily.
Such growth is mirrored by the strong performance of digital assets-focused hedge fund strategies this year.
Hedge Fund Research’s Blockchain Composite Index – which tracks the performance of hedge funds trading blockchain digital currency and distributed ledger technologies (DLT) – soared more than 53 per cent in November, bringing its year-to-date advance to a remarkable 159 per cent.
Similarly, the HFR Cryptocurrency Index has surged 166 per cent since the start of 2020, having gained 57 per cent last month. The benchmark is a performance-based measure of fundamental and quantitative hedge funds that directly trade various cryptocurrencies, including not only bitcoin, but also ethereum and litecoin, as well as new initial coin offerings.
“The infrastructure is constantly improving, and that means there’s more liquidity for more assets, and the fact that funds can go short on assets improves the efficiency of the market,” says Habermacher, whose firm focuses on a broad range of cryptocurrencies, tokens and other forms of digital currency infrastructure, such as blockchain and DLT.
This in turn, has helped foster growing interest among institutional investors, he observes.
Prime movers
Despite its at-times volatile performance, several high-profile hedge fund firms have stepped into the cryptocurrency space in recent years.
Paul Tudor-Jones, the macro-focused founder of Tudor Investment Corp, sees cryptocurrency as an inflationary hedge, and has grown his exposure to the asset this year. Former Fortress Investment Group manager Michael Novogratz now runs a cryptocurrency-focused asset manager, Galaxy Investment Partners. Two Sigma has also begun actively trading digital assets.
Earlier this year, Raoul Paul, a former Goldman Sachs hedge fund manager and CEO of Global Macro Investor, was reported as describing bitcoin as “pristine collateral” and “the biggest trade of our lifetimes” which “reduces the huge black swan of risk of who owns what.”
One prime mover in cryptocurrency strategies has been Altana Wealth, the hedge fund firm set up by Lee Robinson, the veteran Trafalgar Asset Managers co-founder and former Tudor Corp trader.
Robinson first met cryptocurrency and tech entrepreneur Alistair Milne in 2013, and the following year Altana launched its Digital Currency Fund, with Milne at the helm as CIO – one of the first such strategies in Europe which now has one of the longest track records in the market.
The firm followed up in 2017 with the launch of the Altana Cryptocurrency Trade Finance strategy which specialises in lending USD to crypto dealers – “a niche but effective strategy to achieve consistent credit returns”, says Neil Panchen, CTO and PM for Altana Cryptocurrency Trade Finance.
Both the Altana Digital Currency and the Altana Cryptocurrency Trade Finance strategy have generated triple and double-digit returns respectively so far this year.
“There has been a growth in algorithmic strategies as hedge funds have entered the market and transferred quantitative skills across to capitalise on market inefficiencies,” Panchen says of the evolving hedge fund approach.
“Options strategies have also come into play, either as outright strategies or to provide some downside protection, as liquidity, volume and balance sheet / insurance fund backing on exchange has grown. However, the market is not mature enough yet for single strategy funds, like arbitrage and event driven, to perform continuously through the full cycle.”
Strategy surge
Ankush Jain, Aaro’s chief investment officer and co-founder, identifies an assortment of DLT, blockchain and cryptoasset-focused strategies – both fundamental and quantitative – that have tapped into opportunities arising from different areas of the digital asset market.
“Some might focus on short-term trading and cryptocurrencies; others may focus on longer-term and the blockchain space,” Jain says of the prevailing landscape.
Growth can be mixed depending on the market environment at any moment in time, with most of the growth and focus in recent years centring on quantitative strategies. But with the market on a tear this year, fundamental strategies have started to achieve “very high returns”, he adds.
He pinpoints four general distinct strategies in the blockchain and cryptoasset hedge fund space – market neutral, long/short, opportunistic and long-term – which span different approaches and different risk/return profiles.
“Market neutral strategies – which tend to be more quantitative, lower risk and lower return – have been popular because you can generate 15-20 per cent per year after fees with a pretty conservative risk profile,” he explains.
“That’s been particularly popular among institutional investors, who don’t want to take on too much directional exposure to the market.”
He continues: “Long/short funds that are taking a bit more directionality or hedging by going short are seeing more traction. They offer more volume, more liquidity and more ability to trade derivatives and gain indirect exposure.
“In terms of opportunistic and long-term, those are bit more fundamental and DLT/ blockchain specific. They tend to perform better during periods of strong bull markets, when there are more trends happening, and projects kicking off in terms of development and announcements.”
Investor focus
Given the asymmetric return profile offered by some crypto strategies, investors have typically looked to allocate anywhere between 0.5 per cent and 5 per cent into cryptocurrencies, according to market observers.
Appetite among allocators is on an upward trend – but Panchen acknowledges that some institutional investors “simply do not have a mandate” to invest in crypto, particularly those institutions with “long chains of decision making.”
“We are definitely seeing increased investor interest at the moment mainly due to the long-term track records of our funds – six and four years – but also due to the worsening interest rate environment,” Panchen notes, observing how bonds and equities have become “unusually highly correlated” so asset classes that are less correlated are being reconsidered.
He points to “record inflows” into Altana’s strategies over the summer from family offices and high net worth individuals, as well as a longer-term increase in institutional demand since the 2017 high from the likes of funds of funds and digital and tech companies.
“Some private wealth managers still won’t touch crypto even though their clients are asking for it to be part of their portfolio,” he notes. “But family offices that can assess higher risk return strategies and make a decision on this basis are more likely to invest.”
‘A perfect diversifier’
Still, challenges remain for the digital asset hedge fund sector, even amid the 2020’s boom and growing mainstream acceptance.
A survey of more than 40 managers running active crypto hedge funds published by PwC and Elwood Asset Management, a digital assets-focused investment firm, earlier this year pointed to an industry gaining rapid momentum – but one still subject to volatile and unstable returns, where manager survival hinges heavily on fund performance.
Jain also points to barriers on the operational front, and suggests the cryptocurrency sector remains comparatively under-developed compared to other markets where hedge funds trade.
Most crypto hedge funds remain relatively small at under USD10 million in assets under management, he says, which highlights the importance of conducting in-depth operational due diligence.
“Liquidity is increasing, volumes are going up, and the volatility presents opportunity in terms of generating returns. But the crypto market is quite unique, lots of intricacies, transferring assets between wallets,” he notes. “So there is a lot to think about – it’s going to take time before investors and funds are comfortable and service providers can adapt to this environment.”
But despite elements of uncertainty in this still-evolving market, Jain and Habermacher are keen to highlight the sweeping progress made in the sector, in terms of infrastructure, due diligence and liquidity.
“It’s also a perfect diversifier,” Habermacher says, reflecting on the digital asset market’s successes in 2020. “This exciting new asset class is uncorrelated not only to traditional asset classes, but also to other alternative investments.”
