There is scarcity of resources when it comes to crypto hedge funds. Even though cryptocurrency has seen a parabolic bull market for the first half of 2019, global information about them hasn’t always been clear. Elwood, a digital asset investment firm established in 2019, published a comprehensive overview detailing significant qualitative and quantitative analytics.
The Elwood Report is a great baseline for crypto hedge funds in Q1 2019. It took into study 100 crypto hedge funds with the largest assets under management (AuM). Although they admitted that this summary has its limits due to considering hedge funds that are operational during the survey. The report did not include hedge funds that closed due to market issues.
This report could offer amazing insights on how to manage crypto hedge funds. Elwood’s goal is to “encourage sound practices that can be adopted by market participants as the ecosystem matures.” Once established, baseline practices could help the market stabilize as it matures by creating a pattern of practices for crypto hedge fund.
Key Takeaways from the Report (as posted in the report):
While the report dealt with investment and non-investment data, I decided to dissect this report into numbers and descriptions to make it easier for readers to get the gist of the report. The quantitative analysis would deal the numbers, funds, fees, investments and percentages.
There’s Not Much Crypto Hedge Funds With Operational AuMs
Contrary to popular reports saying there are over 350 crypto hedge funds, Elwood reported only 100 hedge funds were still operational Q1 of 2019. This includes only hedge funds that didn’t close after the market shift of 2018. Elwood also excluded (1) Crypto index funds and (2) Crypto venture capital funds (making equity type investments) from their count. In addition, crypto hedge fund managers reported these data and were not verified by a separate entity.
Different Market Types and Analysis
Crypto hedge funds analyzed by Elwood operated using 3 different strategies:
- Fundamental hedge funds are primarily long-term investment period. They have large investor lock-up periods lasting 12 months with an average 90-day notice. These funds usually invest on large projects, early tokenized projects, initial coin offerings and buy and hold liquid cryptocurrencies.
- Discretionary hedge funds have hybrid strategies. They cover a broader range of strategies: long and short, relative value, event driven, technical analysis and token specific projects like generalised mining. They also have a 12-month lock-up period with an average 30-day notice.
- Quantitative hedge funds take either a directional or market neutral approach. They do market-making, arbitrage trading, low latency trading and such. The key of quantitative hedge funds is liquidity. Thus, they have shorter lock-up periods lasting only 6 months with a 30-day average notice.
Average Assets Under Management (AuM) Is Not What You Think
In summating of all AuM from all the crypto hedge funds, the average AuM concluded from the survey amounted to US$4.3 million. This takes into account outlying crypto hedge funds that have larger amount compared to the median value. At fund launch (January 2018), median AuM is US$1.2 million. This implies that revenue over 3x was successful.
The average AuM would be USD$21.9 million, if all crypto hedge fund AuM were calculated. Collectively, crypto hedge funds hold US$1 billion AuM.
Where the Hedge Fund Money Goes
The peak of investor interest was around 2017 when there was a crypto bull market. Around this time, funds that launched ran of the income from the bull market. But as expected, during the second half of 2018, interest dwindled due to the poor market. Launch proved difficult at this time but seems to point a consistent pattern of investors. The recent bull market is being analyzed if it would raise interest in investor similar to 2017.
Based on the Private Placement Memorandums (PPMs), the median management fee is at 2.00%, median performance fee is at 20.00%. Median funds need to have a minimum of six people to pay when the value was taken into consideration. Elwood states that this proves a challenging business operation.
As a result, some crypto hedge funds have looked into other ways of making money. Some have used a market-making strategy, some used an early funding process. But at the current ~75% market run, this is said to be a risky approach. Details of their approach can be seen on the Elwood report.
Analyzed Investment Performance—A Rough Start
With the 2018 market considered, fund performance had a challenging year for crypto. Bitcoin was down by -72% and the median crypto fund return was -46%. This showcases the highly volatile nature of crypto and the poor performance for investors and crypto hedge funds.
However, Elwood argued that most crypto hedge funds used Bitcoin and a benchmark. Therefore, they argued that some crypto hedge funds outperformed their personal benchmark, relative to the movement of Bitcoin price.
When comparing different marketing strategies and their performance, fundamental funds have better performance due to the fact that they handle initial coin offerings and early stage projects. These funds had the choice to exit their investment during the first half of 2018, before the market run on the second half. The discretionary funds have lesser access to ICOs and thus, did not enjoy these benefits compared to the others.
Elwood emphasized that these data were self-reported by the hedge funds and were not verified by any fund administrators.
Aside from investment data, Elwood also reported on qualitative data of crypto hedge funds. These concerned themselves with custody method, team size, governance, counterparty risk, administration, and legal terms.
External Custody vs Sole-Custody—A Working Solution
The use of external custodians are larger compared to self custody. But custody approaches vary largely on the need of the hedge funds.
External custodians are becoming more regulated and are getting insurance. This heightens trust and transparency among crypto hedge funds and thus may be the reason for its use. As traditional hedge funds often use external custodians for assets, the case may not be the same for crypto hedge funds due to private and public keys. Some crypto hedge funds follow regulations where they are not allowed to do self-custody and may also be the reason why external custodians are used more.
Crypto fund managers are looking into practices that could help manage assets in custody. Hot wallets, cold storages, and other innovative ways to hold private keys are becoming more prominent. For hedge funds who use self-custody, an in-house technicians with knowledge and expertise of crypto asset management is very important.
More and more software is being developed for crypto asset management. This is to solve the issues regarding asset custody and management.
It Takes A Village to Handle Crypto Hedge Funds
The report shows an average team size of around 7.5 people, but these people most composed of traditional hedge fund investors and managers. This indicates that more and more veterans and institutions who are already familiar with hedge funds investing are moving into crypto asset. The average years of experience of team management is around 24 years.
As the market continues to grow, more veteran investors are expected to move into crypto asset funding. Third party research use is only 7%. Since crypto hedge funds are relatively new, third party research aren’t as common. Also, some crypto hedge funds prefer to do their own research for different purposes.
The Need for More Experts—Because Some Positions Aren’t Filled
Traditional hedge funds use independent directors. This role is critical in any hedge funds for they are responsible in pointing out decisions with the board of directors. Independent directors hold a different overview compared to the board themselves. However, since crypto hedge funds is a budding market, there are few experts in the field.
Independent directors are counted as accepted expense for hedge funds. As crypto hedge funds progress with more fund governance, it is expected that funds for independent directors will be considered in the future.
Different Strategies, Different Counterparty Risks, Different Frameworks
Depending on the crypto fund strategies, different custody methods are applied. Long funds for example may need cold storage while quick investments would not. Thus, different counterparty risk monitoring are involved.
Fundamental and discretionary funds may need a cold storage and a third party custodian due to its long investment time. Constant monitoring, especially with leverage and short positions, should be applied.
Fund Redemption Time
The liquidity of value assets with crypto hedge funds are quite similar to traditional hedge funds. An average length of 30 days with a 12-month lock up period is expected for discretionary and quantitative funds. While fundamental funds may last up to 90days, but ICO exits can happen if deemed necessary.
As mentioned, the industry is still growing. Thus, there is lack of fund managers for crypto hedge funds. The current data is based on traditional methods of fund redemptions but as the market matures and progresses that fund redemption period may develop.
Location and Regulation Reports
Most crypto hedge funds are located in the United States. This is due to the country’s familiarity with traditional hedge funds. Same legal and regulatory processes are applied to crypto hedge funds. Crypto managers also seem to hail from the United States, again, due to their familiarity and expertise.
However, the data for location and domicility should be taken with a grain of salt. Crypto investment often enter contractual and offshore agreements. Thus, managers may be located somewhere else and use the jurisdiction of the agreement.
A Baseline Data for Future Application
The Elwood report is a comprehensive overview of crypto hedge funds’ existence and performance for the Q1 of 2019. This can be used to project patterns or create a blueprint for strategies of other hedge funds to come. Remember though, that the Elwood report has bias for survivability and did not take into consideration hedge funds that closed. But since the goal is to make the market for crypto hedge funds is longevity this might make more sense to analyze for the meantime.
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