Crypto hedge fund strategies – how have they been performing?
Crypto hedge funds have delivered exceptional returns, far exceeding those of traditional hedge funds.
As the crypto hedge fund space is still relatively small and opaque, hedge fund indices that track them tend to consist of too few constituents, or have strong survivorship bias. Indices for substrategies in the crypto hedge fund space are even more imperfect. The problems with constituents is also compounded by strategy drifts as the market evolves, and disagreements on how to classify the various strategies. Our analysis is based on the performance of funds we track, invest in, or keep in contact with.
Which hedge fund strategies have worked best this year?
The opportunity for excess returns is very significant in the crypto hedge fund space due to the still inefficient nature of the market, and the information asymmetry that favours those with long experience and strong contacts.
Fundamental token selection strategies have performed extraordinarily well year-to-date, with some funds outperforming all market indices often by many multiples. The high dispersion environment was supportive for these strategies, but the best funds’ strong alpha generation also demonstrates the value that expertise can generate in this market. There hasn’t been a strong correlation between returns and the market segment the fund targets (large, mid, small caps) or the approach (whether the investment research focuses on value, narratives, or catalysts). Funds that use a macro overlay (actively managing the market exposure in addition to the token selection) have outperformed in some months.
The better funds in quantitative algorithmic strategies have kept up with the market year-to-date, while others have suffered due to the frequent sharp reversals in the market which were often driven by breaking negative news.
Arbitrage strategies have become less profitable, however, the better managers are finding new arbitrage opportunities as the market evolves (using new instruments, or a wider range of underlying assets). Algorithmic market making continues to generate modest returns only.
Managers that apply quantitative strategies overlaid with discretionary trading (we refer to these as “quantamental”) have performed similarly to purely quantitative strategies this year, suggesting that the discretionary overlay has not yielded meaningful benefits in this period.
Crypto venture capital has had a record breaking period in terms of volumes. It is too early to see how it translates into performance but the early signs are promising.
Some traditional hedge fund strategies don’t yet work well, or at all, in the crypto market (such as long/short market neutral, stat arb/pairs trading), and certain crypto hedge funds apply purely income/yield focused strategies, or strategies that are de facto passive (“smart beta”, enhanced passive exposure) – we exclude these from the analysis as active management plays a very small part in their performance.
We expect that the environment will continue favouring token selection strategies for the rest of the year in terms of the alpha opportunity, but the unstable macro environment and the remaining regulatory risk warrant including more defensive strategies in the portfolio.
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