Digital assets are delivering outsized returns for some active managers while traditional hedge funds fumble

It has been a tough year for active investment managers — but for those that operate in digital assets, the crypto market has softened the blow.

In aggregate, hedge funds have delivered returns of just 2% for the first 8 months of 2020, as noted in a recent report by the Financial Times. Their crypto counterparts, meanwhile, posted returns above 50% since the beginning of the year, according to Eureka Crypto HF Index. 

It's not exactly an apples to apples comparison. To begin with, crypto funds are typically smaller, which makes it easier for a manager to deliver a larger return. Besides that, crypto funds come in more shapes and sizes, ranging from those deploying liquid and venture strategies. 

Still, the disparity in returns highlights the momentum that crypto funds appear to be seeing relative to their stodgy brethren in credit and equities, said Martin Green, who runs crypto quant fund Cambrian Asset Management. And Green has a theory as to why that is.

"Generally speaking, that is because crypto is akin to an emerging equity market," he said. "It is retail dominated, under-researched. Because of these characteristics, it is a very attractive place for those people who do come in an are approaching it from a systematic way or disciplined fundamental strategy." 

"That can translate into a lot of alpha."

And for some funds it has. Green declined to comment on his fund's returns, but Arca's Digital Asset Fund returned more than 200% to its investors since the beginning of the year, according to an investor letter reviewed by The Block. 

The volatility of crypto-assets has helped fuel higher returns for quant funds and certain active managers, according to Green. Since bitcoin is typically three to five times more volatile than equities or stocks, risk-adjusted returns can also be three to five times higher.

Indeed, volatility should have offered a lift for equity investors earlier this year. In March, as as the Covid-19 pandemic first gripped the market, Wall Street's fear gauge surged to its highest level since the financial crisis of 2008. Here's the FT:

"Volatility has remained elevated since the March rout, typified by the tech slump in recent days. An influx of retail traders, sneered at by some as “dumb money”, has fed valuation bubbles, creating opportunities. Competition has also reduced in some previously crowded trades, after March’s extreme volatility forced some traders out of their positions. Privately, managers talk about one of the best trading environments for years."

But, for the most part, funds still found themselves wrong-footed, possibly because their models failed to adjust to unique elements of the pandemic.

For example, take California-based The Voleon Group, which according to the Financial Times has suffered from significant losses this year. The firm's $6 billion AI quant fund shed more than 9% since the beginning of 2020.

Renaissance Technologies also had a rough 2020 with its Renaissance Institutional Diversified Alpha fund declining by more 20% since the beginning of the year, as noted by earlier reporting by the FT. The $75 billion fund is among the best-known in the world and in March it filed an ADV form to permit its Medallion Funds to "enter into bitcoin futures transactions."

It's worth noting that while returns for crypto funds appear to be stronger than traditional funds, a number of bitcoin funds have shuttered this year because of March's meltdown (including Tetras Capital, Neural Capital, and Adaptive Capital). 

Nonetheless, some traders argue that crypto markets represent an opportunity for active management that isn't available in traditional markets simply because they are much less crowded.

"It is impossible to run a hedge fund in a crowded space when you have to put up disciplined numbers every month," one investor commented. "This is 100% because the allocators say they want their hedge fund managers to be differentiated from long term investors, but then pull their money our if a fund has a bad month."

"In crypto we don’t have that problem," another investor said. " It’s a growing asset class with little competition. The sweet spot for active management."

Finally, driving some of the high returns in crypto are the nature in which some token projects are structured, the investor added. 

"The new wave of “pass thru tokens”, which are hybrid utility / hybrid equity securities, are built to pass through value directly to token holders. This makes digital assets the most flexible investment vehicle ever created because a project can pass through anything to its community (revenues, profits, more tokens, discounts, loyalty points, etc). This leads to evangelism and faster project bootstrapping. Which is what leads to incredibly high and quickly achieved returns."

These opportunities could lure certain hedge funds into crypto given their existing lackluster returns, but only if they think they can find an edge over already-seasoned crypto traders. "The exposure can be quite rewarding, but size is the enemy of returns and it's hard for many to very quickly iterate."