Categories: Bitcoin Business

Crypto Funds Are Outperforming – You Shouldn’t Be Surprised

Click here to view original web page at www.coindesk.com

Josh Gnaizda is the founder of Crypto Fund Research.

It’s one of the worst-kept secrets in the alternative investment industry: net of fees, hedge funds struggle to outperform broad equity markets.

In 2007, before bitcoin was even a glimmer in Satoshi Nakamoto’s eye, Warren Buffet famously bet a prominent fund of hedge fund manager $1 million that over the subsequent decade, an S&P 500 index fund would outperform any basket of hedge funds he could put together. Buffet won handily.

It’s not that Buffet didn’t think there were capable investment managers out there; Buffet’s Berkshire Hathaway has often been described as a giant hedge fund. Instead, his confidence relied on his intuition that between fees and trading costs, even the best hedge fund managers would struggle to beat a low-cost index fund.

We might logically assume that crypto hedge funds, which generally have a 2 and 20 fee structure similar to that of their traditional counterparts, would suffer a similar fate.

But since the beginning of 2017, when reliable data became available, the result has been quite the opposite. An equal-weighted index of crypto funds significantly outperformed bitcoin and most other crypto assets.

The CFR Crypto Fund Index tracks more than 40 crypto funds, mostly hedge funds, across a variety of strategies. It shows that even as bitcoin climbed about 1,000 percent between January 2017 and June 2019, crypto funds gained more than 1,400 percent.

The outsized performance of crypto funds over this period might puzzle the Oracle of Omaha, a man who once described bitcoin as “rat poison squared.” Even without Buffet’s bias against crypto or hedge funds, there are a few reasons one might be surprised:

  • Performance fees are by nature punitive to returns during bullish periods
  • Creating a portfolio that can outperform skyrocketing single assets is no small feat
  • Crypto fund managers tend to be less experienced than their traditional counterparts

Despite these apparent headwinds, crypto funds did outperform. So let’s examine these perceptions a bit more.

Performance fees are too punitive in bull markets

Few investment assets have ever experienced a 12-month bull run like that of crypto assets in 2017.

That’s fantastic for fund managers taking home 20 percent of profits, but certainly eats away at returns. Several crypto funds returned more than 1,000 percent in 2017 – meaning by year-end a fund manager could have taken home more in fees than the fund had assets to start the year.

Still, most crypto funds have a 2 and 20 fee structure similar to traditional hedge funds and many have high water marks (essentially to ensure managers don’t get paid for performance when a fund is below all-time high).

So while crypto fund performance fees have been staggering in absolute terms, the fee structure is no more of a hindrance to crypto funds than to traditional hedge funds.

Diversified portfolios struggle to keep up with single assets

It’s hard to imagine any asset overshadowing bitcoin’s 12x performance in 2017. But that’s exactly what happened. Some other coins were up 100x or more. The Bitwise CCI 30 Index, which measures the performance of the top 30 cryptocurrencies by market cap, was up 42x.

So how exactly did crypto funds outperform during 2017? They didn’t. Not even close.

Crypto funds collectively returned a relatively underwhelming 1,000 percent. Sure, these funds returned more in 2017 than traditional hedge funds have in the past 20 years. But everything is relative. And relative to top cryptocurrencies, crypto funds had a disappointing year.

The story of crypto funds’ outperformance truly began when crypto winter cast a chill over the entire industry in 2018. Philanthropist and investor Shelby Cullom Davis said: “You make most of your money in a bear market, you just don’t realize it at the time.”

It was one heck of a bear market.

In 2018, bitcoin lost nearly 75 percent of its value. The CCI 30 Index lost 85 percent. The CFR Crypto Fund Index, however, was down “only” 33 percent. Or put another way, while crypto funds preserved 4/6 of their value, the CCI 30 maintained less than 1/6 of its value. As the chart above shows, this ability to preserve capital during 2018 propelled the crypto fund index ahead of bitcoin and other cryptocurrencies.

From Q1 2017 through Q2 2019, the CFR Crypto Fund Index has returned 1,430 percent. This easily bests bitcoin’s 1,022 percent return and narrowly surpasses the 1,413 percent of the CCI 30.

Crypto funds lack experience

After overcoming their fee structures and whipsawing crypto markets, crypto fund managers had a final hurdle to overcome: inexperience. It’s difficult to directly compare the total financial experience of managers across disciplines. However, we can look at the average age of funds.

A recent study published by Loyola Marymount University (LMU) found the median age of traditional hedge funds was 52 months. This is a lifetime in the crypto world. No crypto funds in the CFR index have been operational for 52 months and the median age is just 16 months.

This inexperience should hurt crypto fund returns, right? Not necessarily. Somewhat counterintuitively, the same LMU study found traditional hedge fund returns decrease with age. And not by a negligible margin. Hedge fund returns in year one were more than triple those in year five. After year five, the study found, “some funds become liquidated and the pattern is somewhat mixed.”

So inexperience, which would seem to be a significant headwind for crypto fund managers, may actually have been a tailwind propelling their performance past ahead of bitcoin and other benchmarks.

Reasons for caution

That crypto funds have outperformed various benchmarks is encouraging. But there’s also plenty of reason for institutions to remain cautious.

The index covers barely one market cycle. Buffet’s index fund didn’t take the lead over hedge funds until year four of the ten-year bet.

The index has less than 50 constituent funds. While the largest in the industry, it’s quite small compared to traditional hedge fund performance indices which can include thousands of funds.

There are potential biases. Since reporting is voluntary, and the index includes less than 20 percent of eligible funds, we can reasonably assume that poorly performing funds are less likely to report. Funds with particularly poor performance might have already closed, creating a potential survivorship bias. Though not unique to crypto fund indices, these biases shouldn’t be overlooked by investors.

Most crypto funds are quite small by traditional standards and it’s quite possible some strategies that perform well in illiquid markets will not support the same type of returns with more capital invested. Bridgewater Associates, the world’s largest hedge fund manages over $100 billion. Crypto funds manage less than $20 billion collectively.

Despite the potential issues, it’s encouraging that crypto hedge funds seem to have done more or less what they are supposed to, namely preserve capital in bear markets. And with the majority of crypto funds in the index now employing outside auditors, custodians and fund administrators, the industry is becoming less haphazard.

The crypto fund industry is still very much in a maturation phase, but with proper due diligence, crypto funds may present institutions, particularly those unwilling or unable to directly custody cryptoassets, an appealing way to get exposure to the sector.

Some decentralized architecture is said to have an “Oracle Problem”, but at least so far, crypto funds don’t seem to have an Oracle of Omaha problem.

Fiat and cryptocurrency via Shutterstock

It’s one of the worst-kept secrets in the alternative investment industry: net of fees, hedge funds struggle to outperform […]

cinerama

Illuminati, Mason, Anonymous I'll never tell. I can tell you this, global power is shifting and those who have the new intelligence are working to acquire this new force. You matter naught except to yourself, therefore prepare for the least expected and make your place in the new world order.

Disqus Comments Loading...
Share
Published by
cinerama

Recent Posts

Everyone’s Worst Fears About EOS Are Proving True

The Takeaway: EOS is the world’s seventh-largest blockchain by market cap, with a value topping $3 billion since February 2019.… Read More

3 hours ago

Street Artist Makes $12,000 in Bitcoin Donations

A French street artist best known for painting lady liberty leading the yellow vests has stated he has received more… Read More

4 hours ago

Wave Financial Launches World-First Bitcoin Yield Fund: Wave BTC Income & Growth Digital Fund

LOS ANGELES, Sept. 19, 2019 /PRNewswire/ -- Wave Financial LLC (Wave), a leading asset management firm focused on digital assets,… Read More

4 hours ago

Nigerian man returns bitcoins worth $80,000

Keith Mali Chung returned Bitcoins worth $80,000 mistakenly transferred to him. A Nigerian man who found $80,000 dollar's worth of… Read More

4 hours ago

Bitcoin Surrenders Post Fed Rate Cut; Pullback Awaited

Bitcoin slipped below $10,000 on Thursday after the Federal Reserve cut benchmark lending rates by 25 basis points.The BTC/USD instrument… Read More

4 hours ago

Bitcoin Hashrate Hits All-time High as Price Dwindles

The benchmark metric of miners confidence in the Bitcoin network established its all-time high on Thursday.Hashrate, which reflects the processing… Read More

4 hours ago

This website uses cookies. We use these cookies to collect data about your interaction with our website for the purpose of continuously improving your experience with our site. For more information we encourage you to read our privacy policy.

Read More