It’s been a minute since we reflected on the performance of hedge funds; 18 months in fact, where an inspection into the rise of ETF popularity could have foretold a decline in hedge fund investing for good. You can read the article here, actually.
Coming at the end of 2017, this was a telling time for multiple sectors of the financial world which are regularly covered on this blog, for better or worse. Namely, hedge funds – which succumb to the latter – and ETFs and cryptocurrencies, who are certainly experiencing a period of positivity currently. With hedge funds closing at an alarming rate (2016 saw 530 shutting up shop), their popularity was dwarfed by exchange-traded funds, an asset class worth around $4.17 trillion in mid-2017, offering fees as low as 0.3% for the thrifty or first-time investor into niche industries including cattle farming and whiskey.
Cryptocurrencies however, whilst hyped to the extreme, went somewhat under the radar considering the role that they could play for fund managers. That seems absurd considering that, in the same month of this aforementioned article (all crypto-heads will likely remember) the hallowed glory days of Bitcoin were here, seeing its price rise to a gargantuan $19,666. Whilst scepticism surrounding Bitcoin’s validity was rife amongst traditional investors, its unconventional revolt against ‘hard’ money had the digitally-minded populace in a frenzy, especially with those prices. 2018 proved to be catastrophic for crypto fanatics however, with these heights plummeting down an avalanching mountain, but are we experiencing a new dawn, an inevitable cause of its volatility? And what exactly does all of this mean for hedge funds?
Well, competition between these more ‘active’ funds and their more ‘passive’ ETF counterparts continues, but hedge funds could reap the benefits of a more hopeful and mainstream outlook on Bitcoin. If ETFs were looking to rule the digital race, hedge funds’ more aggressive battle for solid returns could out-rule niche investment opportunities if institutional investors start getting in on the crypto act, an outcome that’s looking more likely considering financial services’ growing comfort with distributed ledger technology, and dedicated ‘crypto hedge funds’ investing in exactly this.
In one instance that may be radical for digital hedge funds, Amazon Managed Blockchain is looking to be rolled out in the near future, making available the Hyperledger Fabric network which is most suitable for financial companies wanting to protect sensitive information with tight privacy and permission tools integrated into the network. Whilst blockchain is not completely synonymous with digital tokens, it certainly warrants another legitimate use for the trading of digital assets. Bitcoin’s climb since the start of January has been 117% to around $8,000 (at time of writing), signalling somewhat of a renaissance. The entire crypto market as a result has had a $126 billion gain in these 5 months to $237 billion. It’s tough to predict whether it’ll skyrocket or sink in the mud from here, but it’s a positive for its fanbase, and more and more events seem to be cropping up to support its use for financial markets, such as Blockchain Week NYC.
The existence of so-called crypto hedge funds is perhaps a showcase of where hedge funds are headed from here-on therefore. Although the Financial Times has reported the failures of several firms amongst Bitcoin’s nosedive into the trough, 150 have survived the culling to fight another day, now basking in these sunnier days for crypto. These companies usually hold less than $10 million, with the publication again questioning their sustainability, but given their track record of surviving the choppiest and most volatile times recently, the risk doesn’t seem to put them off. Quite ironic considering the hedge fund’s purpose of hedging portfolios against risk.
Digital assets are not just getting the full attention from these firms alone, but ETFs’ lack of progress with them may also play to the advantage of crypto hedge firms too. As has been an ongoing regulatory minefield in the US, the Securities and Exchange Commission is still yet to approve a digital asset ETF product after multiple appeals. Hence, hedge funds with a gate open for investors to look into digital opportunities are somewhat of a scarcity, but able to reap the profits from crypto-optimists. If the future continues to look bright for Bitcoin, the market may open up further, but for now the initial small wins for the coin are the crypto hedge funds’ gain.
Another decisive difference between the offerings from crypto hedge funds and ETFs has been highlighted before: selectivity. Whereas ETFs target a vast array of niche, sprawling, and at times downright bizarre investment opportunities, crypto firms instead have far more tunnel vision, investing only in products and projects related to crypto assets and blockchain technology. These firms dedicate themselves to become trustworthy leaders in crypto-investing, adding to that validity factor. Examples of investment firms specialising in this include Pantera Capital, or Prime Factor Capital, founded by three ex-BlackRock employees.
The one problem it seems for traditional hedge funds is the exodus of its employees to become founders of such companies, taking their institutional finance background into new technological realms, as is the case for the CEO of TrueDigital, as interviewed by The Block. This new manifestation of crypto investment firm highlights the need for older firms to try and adapt to technological times with the hiring of digital experts, keen to research opportunities for digital assets in their portfolios, just as these specialist spin-off firms do with aplomb. It’s just a matter of further education into the space.
Whilst sensitive matters still remain (75% of crypto hedge funds do not have independent directors on their boards, for example), if the ascent of cryptocurrencies continues and regulatory hurdles are finally met by governing bodies in return, it may become the ultimate investment fad once more. These crypto hedge funds that are riding the risky wave could come up trumps and fly the flag for the future of hedge funds and digital wealth. Progress may be stifled by unwelcome precariousness in the crypto market, but it doesn’t seem to have stopped some, and other optimists may certainly be banking on the recent Bitcoin buzz in the months and years to come. Watch this space.