With bitcoin hitting the headlines in recent weeks, reaching an all-time high of USD19,915 on 1 December, investors have been keen to pile in. Even the likes of Bridgewater’s Ray Dalio and Paul Tudor Jones are coming around to the fact that there could be something happening with bitcoin, having made a Lazarus-like recovery since its price tanked close to USD3,000 in December 2018.
With bitcoin hitting the headlines in recent weeks, reaching an all-time high of USD19,915 on 1 December, investors have been keen to pile in. Even the likes of Bridgewater’s Ray Dalio and Paul Tudor Jones are coming around to the fact that there could be something happening with bitcoin, having made a Lazarus-like recovery since its price tanked close to USD3,000 in December 2018.
Such is the intriguing world of alternative coins and digital assets that some investors believe, what we are witnessing is the birth of the next meaningful institutional asset class.
One of those keen to forge a path is Dalpha Capital Management, a new multi-manager investment firm established by Matthew Edwards (pictured). In short, Edwards is hoping to build Dalpha Capital in the image of Grosvenor Capital Management, his former employer and one of the world’s foremost hedge fund of fund managers, founded in 1971 by Richard Elden.
“Everything we are doing at Dalpha Capital is informed by the lessons I learned at Grosvenor. It is well known for developing best practices in hedge fund investing; we want to do the same for digital asset investing,” Edwards says, speaking from Southlake, Texas.
Dalpha Capital – which Edwards says refers to decentralised alpha but equally stands for digitised or democratised alpha – will be a typical Cayman Master/Feeder fund. The focus at the strategy level will be more on the liquid trading, arbitrage side, where Edwards believes there are plenty of opportunities to back institutional-quality managers. “We’ve just finished the fund formation process and finalised our registration from the CFTC, so things are formalising and coming together. We are knee deep in due diligence on 10 funds, at the moment, and we are hopeful of getting six to eight of them over the line.
“We are aiming to begin allocating capital in Q1 2021 based on how those discussions play out,” says Edwards.
After working as a Portfolio Manager and Asia Strategy Head at Grosvenor, Edwards set up a global macro hedge fund, Guard Capital, before deciding to leave the hedge fund industry altogether. He soon found himself looking more intently into the digital asset space, spotting a trend that he felt mirrored the early value proposition of hedge funds, back in their hey day in the 80s and 90s.
“It’s rare you get to invest in a completely new asset class,” he says.
“In many ways, digital assets are the antithesis of efficient capital markets; you’ve got incredibly fragmented microstructure, a preponderance (still) of retail flow, and a limited amount of sophisticated competition trading this asset class. That’s what really got my wheels turning on why this could be an interesting opportunity to present a potentially alpha-rich environment for professional practitioners, who know what they are doing.
“I ended up working with a group called Diginex in Hong Kong, who essentially aim to become a digital asset investment bank.
“I helped them out with a number of strategic issues and came to realise they wanted to build an asset management business, at the centre of which would sit a crypto fund-of-funds. I was the obvious candidate to take over that business and grow it, and in doing so, I decided…why not run my own start-up?”
Edwards spun out from Diginex at the end of 2019 and relocated to Southlake, equidistant to Dallas and Fort Worth.
Dalpha Capital’s concentration exposure in the portfolio is expected to be dominated by the top five alternative coins at any given time, with Edwards confirming a small amount of cash will be retained for ‘fundamental’ strategies, which are more directional in nature, and for strategies lower down the liquidity curve.
When asked what he thinks about the polarisation of views on digital assets, which arguably has more advocates and critics than any other area of contemporary investing, Edwards pauses for reflection, before saying:
“There used to be a time when traditional hedge funds actually delivered on their original promise of maximising absolute and risk-adjusted returns but many don’t do that anymore because on balance, the inefficiencies have been stripped away. And what used to be a genuine pursuit of 20 per cent-plus annualised returns is now a LIBOR plus return model on a fee structure that has seen massive compression.”
Over the last decade, there has been a concerted effort by central banks to strip away volatility from the marketplace. Consequently, the opportunities for hedge funds to deliver outsized returns have dwindled.
Within digital assets, intra-month moves average in excess of 30 per cent; just look at bitcoin and ether. They have a trailing 90-day annualised volatility in excess of 50 per cent.
“In my view, this creates a pretty robust opportunity set for traders and arbitrageurs to come in and exploit the inefficiencies on offer,” opines Edwards.
The three UUUs principal
In a recent article that highlighted why Dalpha Capital views the digital asset space so favourably, it made reference to a paper published by Harvard economist Richard Zeckhauser entitled Investing in the Unknown and Unknowable.
In brief, it examined how certain legendary investors “have earned extraordinary returns by investing in the unknown and unknowable”.
These “UU” situations describe a condition of general ignorance where the future state of the world is unknown and the probabilities of potential future states are unknowable (ie, there is no historical precedent upon which to base future projections).
Zeckhauser went on to suggest that certain situations merit a third U; uniqueness.
These are situations where there is a dearth of professional investor involvement and such inattention can lead to significant mispricings.
Unsurprisingly, Edwards sees clear parallels with digital asset investing:
“The digital asset space is the quintessence of the unknown, the unknowable and the unique. That has been how some of the most profitable and successful traders of all time have done it; by focusing on such opportunities. I see a lot of parallels to this in the digital assets space. The future of digital assets is unknown, it is unknowable in the sense there is no historical precedence on which to base a probability-weighted outcome, and it is unique because not a lot of people are doing it.”
Edwards and the team will be screening managers who already have a strong asset management background and who are running original strategies with respect to trading and arbitrage.
“Traders could be either systematic or discretionary,” he says, “while arbitrage tends to evolve rather quickly. It’s similar to the early days of Citadel and Elliott, where all they did was trade convertibles. Ken Griffin traded converts out of his Harvard dorm room, for example. Now those shops have grown to become some of the most successful multi-strategy shops of all time.
“I think you’re going to see a similar evolution among arbitrageurs in the digital assets space.”
Speed of evolution
One of the hallmarks of this asset class is the speed at which it is evolving. While the initial convert arbitrage trade lasted for over a decade in the hedge fund industry, for crypto strategies the timeframe is far more compressed and truncated.
“Einstein once said, ‘Nothing will benefit human health and increase the chances for survival of life on Earth as much as the evolution to a vegetarian diet.’
“In a similar vein, I believe that necessary for the survival of a crypto hedge fund is the evolution towards a multi-strategy approach, simply because this market moves so quickly,” states Edwards.
Indeed, Dalpha Capital views itself very much as a multi-strategy fund, more than a standalone fund-of-funds, per se. Structurally, it will look and feel like a fund-of-funds, since it will be allocating capital to third party managers and will not be trading any crypto assets on its own balance sheet.
And as Edwards concludes:
“The types of return we seeking are going back to the original premise of what a hedge fund could offer investors; the aim is to generate genuinely attractive absolute and risk-adjusted returns in relatively uncorrelated fashion.
“We want to set out to achieve the same sort of success Grosvenor enjoyed institutionalising hedge fund investing. If we can replicate a fraction of what Grosvenor stands for, as an institutional standard bearer, we’ll be very happy.”
