Amid a choppy market, new data shows that hedge funds with crypto strategies offer less volatility than crypto exchanges overall.
In an exclusive analysis for Institutional investor, Markov Processes International concluded that cryptocurrency hedge funds tend to perform on par with Bitcoin but with less downside risk. The analysis also found a large amount of dispersion between the funds.
“These hedge funds add value, but you have to know what you’re doing,” said Michael Markov, CEO of the namesake firm. “There are companies out there with pending funds. Diversification also helps.”
The analysis is especially relevant after two months down for most coins tracked by CoinMarketCap. However, this is par for the course for cryptocurrency investors.
“This kind of volatility that we’ve experienced is not surprising,” said Joe Marenda, global chief investment officer for digital assets at Cambridge Associates. “Honestly, a 50 percent reduction in crypto is expected.” What is new, however, are flashpoints like the explosion of the Luna/Terra stablecoin and crypto lender Celsius’s decision to freeze withdrawals earlier this week.
According to MPI analysis, the Eurekahedge cryptocurrency index tracks at almost the same rate as Bitcoin. At first glance, this shows that investing in a cryptocurrency hedge fund could yield similar returns to a single token, with higher fees.
But a deeper dive shows that there is significant dispersion between the best and worst performing funds, as well as other benefits for investors.
MPI used a data set of 51 hedge funds, those with a track record of at least three years and included in the Eurekahedge or HFR universe. The number is less than the total number of cryptocurrency hedge funds because MPI excluded newcomers and single-currency index funds.
Since 2018, the lowest spread between the best and worst performing quartiles was 39 percent. The tallest? Almost 200 percent. The analysis noted that the dispersion among these funds is even greater than that of private equity firms.
MPI excluded the top five percent and bottom five percent of returnees in this analysis to exclude outliers.
“The spread is really wide,” Markov said. “Simply investing in average funds doesn’t mean anything. You see this crazy scatter. It is very important where you invest.
According to Marenda, the wide dispersion of performance warrants greater attention to managers’ analysis.
“As long as you have this level of dispersion, that’s when you can generate extraordinary returns by doing good due diligence and selecting managers,” Marenda said. “In crypto, you have an absolute need to do very good due diligence and manager selection.”
Marenda added that the latest crypto crash has revealed to investors that these funds take different approaches to risk management. “Some funds abandoned their position in Luna in December when they started to get an indication that the funds were not sustainable,” she said. “Other funds sold part of their position in the first quarter; others sank it into the ground.”
To dig deeper into risk and volatility, MPI created three equally weighted sample portfolios of ten hedge funds. The first was ranked by those with the most attractive Sortino index, a variation of the Sharpe index that only includes the downward standard deviation, the second for total return and the third for assets under management.
What the data showed is that over a three-year period beginning in May 2019, those with the most attractive Sortino ratios slightly outperformed Bitcoin, with a significantly lower annualized semi-standard deviation. While Bitcoin’s annualized semi-standard deviation was around 37 percent annually, it was around 10 percent for Sortino’s index portfolio, according to the data.
MPI used a Sortino ratio because it only wanted to measure downside risk, but Sharpe ratios are also important here.
“These are high Sharpe ratio opportunities,” Marenda said, estimating that for some of these funds, that ratio is two or three. The Sharpe ratio is measured by subtracting the risk-free rate (market beta) from a portfolio’s return and then dividing it by the standard deviation of the excess return. A Sharpe ratio of 0 means that a portfolio has the same beta as the market as a whole.
Beyond these ratios, MPI sample portfolios revealed that, even for the top 10 returns and 10 largest funds, investing in a hedge fund structure would result in lower volatility than investing directly in Bitcoin. Even the HFR Blockchain Composite and Eurekahedge Cryptocurrency indices showed lower volatility.
“It’s comforting,” Markov said. “It should provide some comfort to investors that arbitrage, hedging and diversification are worthwhile in that space.”