Crypto assets have been amongst the fastest-growing asset classes in recent years. This new asset class has attracted a diverse set of investors, ranging from traditional institutional investors to more nascent investors keen to play a role in the innovation and transformation that blockchain technology promises. Although the nature of this asset class is somewhat speculative and its fundamentals have been questioned by some academics, many retail investors in their search for high returns during a long period of low-interest rates have added crypto assets to their portfolios. The public awareness of the performance of Bitcoin, the largest and the most popular cryptocurrency, has driven the prices and trading volume of the other crypto assets, and social media trends and micro-blogging platforms have also fueled their popularity. This trend accelerated after the COVID-19 pandemic. Empirical research indicates that COVID-19 has positively impacted the cryptocurrency through a mechanism called Herding Behavior. The pandemic spread fear and anxiety amongst investors and in turn caused an increase in the trade volume of crypto assets in the investors’ search for high-return assets [1]. Additionally, the governmental stimulus packages introduced to address the outbreak had positive impacts on the crypto assets market. These stimulus measures are characterized as a wealth shock for households and caused a significant increase in cryptocurrency buy-trades [2].
In addition to individual investors, some institutional investors also tend to include digital assets in their portfolios. This group seeks to benefit from diversification advantages and high returns of crypto assets. However, the highly volatile and speculative nature of crypto assets remains controversial. New funds specialized in digital assets, blockchain, and crypto asset classes have also emerged and the rate of new funds appearing has accelerated since 2020. Although the background factors responsible for the crypto assets and by extension crypto funds’ success have been gradually changing in recent months and a new market situation is forming due to the inflationary pressures, a high expected level of interest rates, and a strategic shift from growth investing to value investing, the net investment flow towards this new asset class remains positive. An analysis using AlternativeSoft supports the aforementioned statement. It shows that from the beginning of 2020 onwards, over 11,459 million dollars have flowed into USD-denominated hedge funds specializing in blockchain and digital assets (see Table 1).
| Location | Crypto Hedge Funds (Million USD) |
|---|---|
| North America | 11,143 |
| Europe | 175 |
| Latin America | 120 |
| Asia | 20 |
| Total | 11,459 |
Cryptocurrency funds exhibit track records of extremely high positive returns. Their annualized returns in some cases exceed hundreds of percent. Even adjusting their returns using traditional risk-based measures does not change the fact that these funds outperform the conventional market benchmark. The literature on cryptocurrency funds’ performance supports the argument that cryptocurrency fund managers generate significantly positive alphas compared to conventional benchmarks and this extreme outperformance is unlikely to be explained by pure luck [3].
What about the quality of the alpha they generate? Is this obvious outperformance rooted in the fund manager’s skill or is this simply a case of “being in the right place at the right time”? Is investing directly in the basket of cryptocurrencies better than paying a fund manager to do so on your behalf? The importance of these questions increases when considering the fact that the average performance and management fees for such Crypto Hedge Funds are 21.04% and 1.69% respectively. Investors are paying a premium as the market average for hedge funds is 19.92 and 1.02% respectively (based on calculations using AlternativeSoft).
AlternativeSoft addresses these questions by comparing the performance of an equally weighted portfolio of Crypto Hedge Funds with the return of an equally weighted portfolio of the 10 largest cryptocurrencies based on their market capitalization. The ultimate aim is to analyze the performance of the Crypto Hedge Funds against our benchmark to see if the Crypto Hedge Funds are outperforming the largest cryptocurrencies and therefore justifying their fees.
To conduct this analysis, a 6-step process has been followed:
1. Hedge funds active in cryptocurrency, blockchain, and digital assets strategies since the start of 2020 were selected using AlternativeSoft databases. It was important to ensure the funds invested in cryptocurrencies and not in companies associated with the space.
2. Crypto Hedge Funds that existed at the start of 2020 but subsequently died were included in the universe to eliminate the survivorship bias.
3. The passive funds/trackers were removed to satisfy the aim of research in evaluating the performance of Crypto Hedge Funds’ active management.
4. An equally-weighted portfolio of the remaining funds was constructed for performance evaluation purposes.
5. A basket of the 10 largest cryptocurrencies based on their market capitalization at the start of 2020, excluding the stablecoins, was selected.
6. The performance of the portfolio specified in step 4 was evaluated against the benchmark specified in step 5 using the AlternativeSoft analytical solution.
The results indicate that active Crypto Hedge Funds beat the performance of the equally weighted basket of cryptocurrencies. They outperform the cryptocurrency basket by 5.14% on an annual basis. These funds also provide their investors with better volatility-based metrics (see Table 2) and they collectively generate a high positive annual alpha of 29.66% against the cryptocurrency basket.
| Crypto Hedge Funds |
Cryptocurrency Basket |
Difference | |
|---|---|---|---|
| Annualized Return | 83.24% | 78.11% | 5.14% |
| Annualized Return Last 1 year | -12.76% | -48.79% | 36.21% |
| Annualized Volatility | 51.91% | 100.39% | -48.48% |
AlternativeSoft’s analytical solution also shows that the reward the Crypto Hedge Funds generate per unit of volatility, both positive and negative volatility, exceeds those of the direct investment in cryptocurrencies. Table 3 exhibits a comparison of Sharpe and Sortino ratios for the Crypto Hedge Funds and the cryptocurrency basket.
| Crypto Hedge Funds |
Cryptocurrency Basket |
|
|---|---|---|
| Annual Sharpe Ratio | 1.25 | 0.59 |
| Annual Sortino Ratio | 2.40 | 1.17 |
It can be concluded from Tables 2 and 3 that Crypto Hedge Fund managers are adding value and this value gains further importance considering the self-custody nature of cryptocurrencies and the security threats this poses.
This result again supports the fact that there are valuable opportunities in this sector that can be exploited by conducting thorough analysis and research.
In this article, we used AlternativeSoft to analyze Crypto Hedge Fund performances since the start of 2020. We found that Crypto Hedge Funds not only generate significant positive alpha compared to conventional hedge fund factors, but they also outperform a new benchmark formed by equally investing in a basket of the 10 largest cryptocurrencies. This outperformance can be attributed to the Crypto Hedge Fund managers’ skills implicating that the funds’ added value justifies their performance and management fees. This emphasizes the advantages of Crypto Hedge Funds over direct investment in the cryptocurrency market specifically when it comes to the security concerns related to direct investment in cryptocurrencies.
[1] E. Mnif, A. Jarboui, and K. Mouakhar, “How the cryptocurrency market has performed during COVID 19? A multifractal analysis,” Finance Res. Lett., vol. 36, p. 101647, 2020.
[2] A. Divakaruni and P. Zimmerman, “Uncovering retail trading in bitcoin: The impact of covid-19 stimulus checks,” Federal Reserve Bank of Cleveland, 2021.
[3] D. Bianchi and M. Babiak, “On the performance of cryptocurrency funds,” J. Bank. Finance, vol. 138, p. 106467, 2022.
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N.B. This article does not constitute any professional investment advice or recommendations to buy, sell, or hold any investments or investment products of any kind, and should be treated as more of an illustrative piece for educational purposes.
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