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Actively Managed Crypto-Currency Strategies

Crypto-currency funds continue to dominate hedge fund performance league tables’ thanks largely in part to the gravity defying price of bitcoins. In fact since we first published an index tracking the performance of crypto-currency investing hedge funds earlier this year, the price of bitcoin, the most liquid and the shiniest of all crypto-currencies has almost quadrupled. While opinions around the future of crypto-currency have become increasingly polarized, the enviable price appreciation continues to attract actively managed funds towards investments in crypto-currencies.

Shortly after the start of 2017, Bitcoin price broke US$1000 mark for the first time in three years, bringing it close to its previous peak price in 2014. In March, the US Securities Exchange Commission (SEC) rejected two applications to operate Bitcoin tracking ETFs. The first application that was rejected in 10 March came from Tyler and Cameron Winklevoss, and Bitcoin price slumped over the following week. The second application came from Intercontinental Exchange Inc., and was rejected in 28 March. This rejection didn’t seem to leave a noticeable impact on Bitcoin price because it was overshadowed by Japan’s declaration of Bitcoin as a legal tender three days later. Since then Bitcoin has been rallying at an incredible rate, despite seeing noticeable dips all over the place. It broke US$2500 mark around the end of May, surpassed US$5000 mark in October, and currently sits at $8116.13 as of 21 November 2017. The year 2017 also saw two splits that gave birth to new Bitcoin derivative currencies: Bitcoin Cash in 1 August and Bitcoin Gold in 23 October.

Figure 1 shows the performance of actively managed crypto-currency strategies against a Bitcoin Price Index constructed based on the monthly closing price for bitcoins since June 2013. The Eurekahedge Crypto-Currency Fund Index displayed in the chart below tracks the performance of nine actively managed ‘Alternative-Coin’ funds that carry exposure to Bitcoin, Ethereum and other crypto-currencies. The index is equally weighted, USD denominated and captures the performance of liquidated crypto-currency funds to account for survivorship bias. The constituents for this index employ a variety of trading strategies to profit off the price movements in the underlying crypto-currencies, including but not limited to arbitrage, event driven (regulatory driven), momentum as well as shorting on a limited scale given the liquidity constraints. Like other alternative strategies, their overall objective is to capture some of the upside whilst minimizing losses on the downside to maximize returns to the crypto-currency strategy from actively timing the market.

Over the 52-month period shown in Figure 1 starting as of end June 2013, the Eurekahedge Crypto-Currency Fund Index has returned a cumulative of 10838.38% in contrast to a return of 6512.32% for the Bitcoin Price Index. On an annualised basis, this comes to 195.48% for actively managed crypto-currency strategies versus 163.08% for the Bitcoin Price Index. As can be expected, the strategy is massively volatile given all the uncertainties surrounding the current use and future of crypto-currencies – with annualised standard deviation for the Eurekahedge Crypto-Currency Fund Index coming in at 204.92% compared with 235.38% for the Bitcoin Price Index. Unsurprisingly, the crypto-currency funds rank among the top most volatile hedge fund strategies as tracked in the Global Eurekahedge Hedge Fund Database.

Figure 1: Crypto-Currency Fund Index Vs Bitcoin Price Index
ILS Advisers Hedge Fund Index since December 2007

Figure 2 captures the excess returns or alpha for crypto-currency hedge funds relative to the price of the underlying as measured by the bitcoin closing price index. Two limitations of this approach need to be underlined before we draw any conclusion from the chart – a) the closing price for bitcoins does not capture the daily price movements which can be quite significant as we have seen in recent weeks; b) crypto-currency funds are not limited in terms of their exposure to just bitcoin and allocate to other crypto-currencies as well. The second limitation however can be deemed weak given how bitcoin enjoys a preeminent role among cryptocurrencies and in essence captures the pulse of the market. However, in case of further doubt regarding this, the high R-squared values for a regression of manager returns versus bitcoin prices seem to further back up this conclusion. So in essence what the chart essentially shows is that crypto-currency fund managers have for the most part delivered positive alpha net of fees.

Figure 2: 12 month rolling alpha for Crypto-Currency funds relative to Bitcoin Price Index
Crypto-Currency funds relative to Bitcoin Price Index

Table 1 summarises the key performance statistics for Crypto-Currency funds relative to their peers.
Key takeaways include:

  1. Crypto-currency funds have outperformed the average global hedge fund, traditional FX hedge fund strategies, the MSCI ACWI and the S&P GS Precious Metals Index over all periods depicted in Table 1 excluding 2014 when the strategy was down 52.04%.

  2. Barring 2016, crypto-currency funds have outperformed the Bitcoin Price Index with the most significant outperformance coming in H2 2013. It would be pertinent here to note that the closing monthly price for the Bitcoin Price Index will not capture the intra-month price movements, something which the actively managed crypto-currencies have likely capitalized on to deliver outsized returns relative to the underlying.

  3. Over both the 3 and 2 year annualised period, crypto-currency funds have outperformed their peers delivering annualised gains of 181.37% and 358.41% respectively over these periods. Compared to the Bitcoin Price Index, actively managed crypto-currency strategies have also posted relatively lower volatilities over these periods resulting in better Sharpe ratios.

  4. With regards to maximum drawdown over the period under consideration, the Eurekahedge Crypto-Currency Fund Index has fared relatively better compared to the underlying Bitcoin Price Index. However, when the maximum drawdown of the strategy is compared against Traditionals and hedge fund strategies, the riskiness of the strategy becomes quite apparent. Over a period of 14 months between December 2013 and January 2015, the Eurekahedge Crypto-Currency Fund Index lost almost 74% of its value from its 2013 high. In contrast the Bitcoin Price Index lost almost 81% of its value.

Table 1: Performance in numbers – Crypto-Currency Fund Index vs FX Hedge Fund Strategies and Traditionals

Eurekahedge Crypto-Currency Hedge Fund Index
Bitcoin Closing Price Index
Eurekahedge FX Hedge Fund Index
Eurekahedge Hedge Fund Index
S&P GS Precious Metals Total Return Index
2013 2H
2017 October YTD
Annualised returns since July 2013
Annualised volatility since July 2013
Sharpe Ratio since July 2013 (RFR=1%)
3 year annualised returns
3 year annualised volatility
3 year Sharpe Ratio (RFR=1%)
2 year annualised returns
2 year annualised volatilities
2 year Sharpe ratio (RF =1%)

Source: Eurekahedge

Table 2 shows the correlation matrix of crypto-currency funds with respect to their peers identified. Not surprisingly, the funds have a near perfect positive correlation to the most liquid crypto-currency out there (bitcoins). Correlations to hedge fund strategies, the MSCI and S&P GS Precious Metals are not statistically significant over the 52-month period analysed. It would be interesting however to see how the correlations evolve between crypto-currencies and precious metals if the former is successful down the road in gaining acceptance as legal tender and partially displacing fiat currencies. Though it remains to be seen if crypto-currencies can successfully side-step regulations and avoid acquiring some of the characteristics common to fiat currencies.

Table 2: Correlation matrix
Correlation matrix

Source: Eurekahedge

Figure 3 plots the monthly returns for the Eurekahedge Crypto-Currency Fund Index and its outperformance/underperformance relative to the Bitcoin Price Index. Actively managed crypto-currency funds have generally outperformed the Bitcoin Price Index, with their steepest underperformance occurring in November 2013 when they underperformed the latter by almost 44.72% as Bitcoin prices soared on Chinese demand. During months when the Bitcoin Price Index ended in the red – the average loss amounted to 12.72% while crypto-currency funds recorded a loss of 7.70%. Similarly when the Bitcoin Price Index ended in the green – the average gain amounted to 37.43% while that for crypto-currency funds came in at 33.15%.

Figure 3: Monthly returns for Crypto-Currency funds and relative performance
Crypto-Currency funds and relative performance

Source: Eurekahedge

Currently just a handful of funds are venturing into the ‘alternative coin’ space, and the current AUM overseen by these strategies is just shy of US$1 billion. While there is interest from high net worth individuals around this emerging digital asset or currency, institutional capital has largely steered clear of cryptocurrencies. Traditional FX hedge fund strategies have kept themselves largely out of the domain of crypto-currencies, but assuming for a moment that the aforementioned correlation between Crypto-currency strategies and FX hedge fund strategies is meaningful, a mere 0.49% allocation to the former strategy since July 2013 would have improved the annualised returns for FX hedge funds by 0.61% at the expense of 0.17% increase in annualised volatility, resulting in an overall improvement in the Sharpe ratio from 1.47 to 1.69. Whether a small incremental exposure to crypto-currencies is merited yet remains to be seen given the uncertainties surrounding its very existence which stem from the threat it poses to fiat currencies and the traditional mechanisms that underpin transactions in any economy. But for the moment, cryptocurrencies continue to defy gravity and the more they do so, the more their mention becomes synonymous with a bubble.

The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.

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