Investment

Family offices are fueling the boom in crypto-hedge funds – now the only bull market in town

Hedge funds prey on volatility and cryptocurrencies produce plenty of it. So returns can be off the scale, as shown by the Eurekahedge crypto hedge fund index which boasts an annualised gain of 105% since inception.

Family offices reaped some rich rewards, after responding to the opportunity. Singapore-based Defi Consulting Group explains: “High net worth individuals and family offices often have less regulatory compliance to deal with than other regulated financial institutions”.  

There are still many inefficiencies in digital assets and I know quite a few quants using their old algos from traditional asset classes to create sustainable alpha in crypto

The best monthly gain for the Eurohedge index is 405% and its worst monthly loss is -34%.  This produces a gain of 46,700% since inception, against 40,000% from bitcoin. 

Dan Morehead’s Pantera Bitcoin Fund has done even better, returning 65,000% in nine years.  In 2021, the Eurekahedge index returned 140%. It fell 15% in the first two months of 2022, but cryptocurrencies fared worse.

Volatility can cut both ways but, for now, no one needs to talk about failure.  According to a 2021 PwC report, 84% of money invested in crypto hedge funds worth $4 billion came from wealthy investors and family offices. 

Family offices accounted for 30% of the total after responding to marketers who knew they would gain little support from institutions. Marketing has been aided by the development of Actively Managed Certificates, pioneered in Switzerland, which provides easy access to strategies. 

Similar factors led to direct investment in crypto by family offices, cheered on by their next generation. According to a BNY Mellon poll, 77% of family offices now invest in crypto.

Outstanding returns help to explain continued family office loyalty to crypto and its hedge funds. 

Their money plays a big role in funding for blockchain ventures which rose eight-fold to $25.2 billion in 2021, according to CB Insights. Despite Ukraine, VC finance of $2 billion continues to flow into the sector. 

More than twenty family offices are proactive crypto VC investors, according to FamCap Analytics with many more striking occasional deals. 

The range is breathtaking.  Australian family office, Victor Smorgon Group, recently backed a crypto platform called Zerocap which supplies custody and asset servicing.

Over in the metaverse, Bob Iger, former Disney chief executive, has invested in avatar supplier Genies, backed by Solon Mack Capital family office whose founders made their fortune in real estate.

Family office principals enjoy their freedom to live life at the cutting edge. In the 1970s and 1980s, they were eager backers of hedge fund pioneers Julian Robertson, Bruce Kovner and Louis Bacon during their glory years.

Following the credit crisis of 2008, they fell out of love as hedge funds were commoditised and competed to invest $3 trillion in markets swamped by excess liquidity, risk-averse institutional clients, passive investment, a battle for tech supremacy and high-frequency trading.

Contemplating the ruins, Nicolas Rabener, chief executive of FactorResearch, said in a recent blog: “Alpha on traditional markets has been almost completely arbitraged away.” 

Transferring skills to the crypto sector have proved far more lucrative. Rabener says: “All classic hedge fund strategies are being deployed.”

Quant is the most popular strategy with 37% of the crypto hedge fund market, according to PwC. 

Fund provider Alt Alpha Digital points out crypto trading is currently dominated by individuals who base their decisions on chart patterns and only end up reinforcing trends. 

Marc Bernegger, co-founder of AltAlpha, said: “There are still many inefficiencies in digital assets and I know quite a few quants using their old algos from traditional asset classes to create sustainable alpha in crypto.”

Seasoned quant managers are far more informed in price discovery, diving deep into blockchain data for factors like transaction values and the scale of fees paid to miners. They can also spread their wings to look at the potential of other blockchain applications like payments,  Non-Fungible Tokens, and the metaverse.

As AltAlpha says: “Many areas across our society and economy are being transformed…by borderless and trustless interaction based on decentralised, code-enforced, platforms.”

According to Deloitte, a blockchain ledger offers savings of 40% to 80%, as transactions dispense with intermediaries. New tools and instruments such as options strategies developed from Goldman Sachs and futures-driven ETFs are multiplying.

Institutional investors have also been reassured by the growth of crypto custodians, along with US President Biden’s request for  regulatory clarity. 

Their money is providing a crucial tailwind for hedge funds that are better equipped than most to calculate the implications. And institutions are also starting to demand a slice of the hedge fund action.

According to DEFI Global: “Institutions are not yet prevalent investors in crypto hedge funds. Going forward, however, this is expected to change, with the investor mix between HNWIs, family offices and institutions evening out.” 

Mainstream hedge funds are increasing allocations to crypto to 5% or 10%. Billionaire hedge fund managers Steve Cohen, Alan Howard and Paul Tudor Jones are big investors. After resisting for years, Ken Griffin of Citadel Securities is reversing his anti-crypto stance. Ray Dalio of Bridgewater admits to owning bitcoin. 

The growing interest of hedge funds in crypto will create a fairer, less volatile, market for cryptocurrencies. It will also be disruptive. One recent trade, reported by Bloomberg has seen managers shorting Tether, a stable cryptocurrency linked to the dollar, which underpins bitcoin trading. 

In due course, crypto booms and busts will become less intense. And, as Rabener of FactorResearch points out, outsized returns from crypto hedge funds will get arbitraged away, just like everything else.

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