What are quantitative hedge funds

Crypto Hedge Funds: Why Quantitative Crypto Funds Work

Crypto hedge funds are becoming increasingly popular. In the guest article, the expert Marc Bernegger provides information about why this is - and where the journey is headed.

Marc P. Bernegger is a serial tech entrepreneur. In 1999 he founded his first internet company. Since then he has already booked two successful exits to listed companies. He started working with Bitcoin in 2012 and is a board member of several companies. These include the Crypto Finance Group, the Swiss Blockchain Association, the Crypto Finance Conference St. Moritz and others. Bernegger is also a member of the World Economic Forum's network of experts on blockchain and the digital economy. He also initiated the platform CryptoFund.News with a focus on crypto hedge funds.

Based on the current annual "Crypto Hedge Fund Report 2020", which the auditors at PricewaterhouseCoopers (PwC) publish together with Elwood, the most common crypto hedge fund strategy is the quantitative one (48 percent of the funds). This is followed by a discretionary long strategy (19 percent), a discretionary long / short strategy (17 percent) and a multi-strategy (17 percent).

But why do almost half of all crypto hedge funds worldwide focus on quantitative strategies? There are a number of reasons for this.

Quantitative crypto funds: advantages and features

  • Systematic strategies are superior to human decision-making processes in an environment of irrational and volatile markets.
  • The market is still dominated by traders who make their trading decisions by observing price movements. This increases the strength of trends and favors a quantitative approach based on time series analysis.
  • It is important to note that the models used by quantitative funds typically go beyond the digital asset records. With many quantitative crypto fund managers hailing from the traditional financial world, their strategies are trained in decades of data from traditional asset classes and are thoroughly tested before being applied to the crypto market.
  • The amount of information that can be obtained by analyzing digital asset records is quite large. This is especially true if on-chain metrics (e.g. transaction values, miner fees, etc.) are taken into account. Because those can be used by quantitative funds to gain some element of predictability versus simply relying on technical price data.
  • When it comes to outliers, most quantitative strategies can take advantage of the short-term inefficiencies of digital assets and actually benefit from outliers. The attraction of many quantitative funds is their informational advantage in the market and their hedging possibilities, especially in declining markets. As such, outliers pose a challenge, but have proven to be quite profitable for some quantitative funds.
  • A long / short approach that follows trends does not require a forecast of (fair) prices in the underlying market.
  • Simple and generic approaches seem to work better and more reliably compared to highly complex analytical methods. This is especially true when they are applied to the young crypto markets.
  • Additional filtering methods to eliminate the volatility of the underlying crypto markets dampen activity and lead to more stable results.

Results and performance are paramount

Also interesting: Most reputable and regulated quantitative crypto hedge funds present their numbers quite transparently. This enables investors to find the assets actually managed or the monthly performance on platforms such as Barclay Hedge or Nilsson Hedge.

Based on the data available, it is evident that quite a few systematic crypto hedge funds clearly and consistently outperform passive “holding strategies” and generate solid and sustainable excess returns.

Quantitative Crypto Hedge Funds: The Ecosystem Is Growing

There is a growing number of hedge funds that only invest in (quantitative) crypto funds, so the whole ecosystem is growing and developing quite quickly.

More and more talent from the traditional hedge fund world is moving into digital assets, including some of the old hedge fund titans like Paul Tudor Jones.

Wall Street also seems to be much more open to viewing Bitcoin as a new asset class. Well-known Wall Street names like George Ball are also there. The former Chief Executive Officer of Prudential Securities suggested that Bitcoin and other cryptocurrencies could represent a "safe haven" for investors and traders looking for alternative investments.

Investor demand is increasing massively

Most regulated crypto hedge funds that accept money from outside investors are fairly transparent when it comes to their performance and assets under management. Looking at the increased assets invested in crypto hedge funds over the past few months and the fact that Bitcoin serves both as a digital store of value and as a new hedge against inflation, it turns out that investor demand is on the rise.

More than half of all crypto hedge funds in existence today were founded less than three years ago, which shows how young this industry is.

The assets under management of crypto funds worldwide tripled in the last year (from about two billion in 2019 to six billion in 2020). Much of this new money has been allocated to quantitative trading funds.

Crypto hedge funds: interesting times are ahead

Investing in a crypto hedge fund rather than directly in the market offers a more attractive option for many investors. Because you don't have to worry about custody (safekeeping), best execution (fastest possible execution) and liquidity bottlenecks. This is especially true for traditional investors who are not deeply involved in the underlying technology. Because they see cryptocurrencies primarily as a new alternative asset class to secure their existing portfolio.

It remains to be seen how the entire market will develop in 2021. But there are many arguments why quantitative crypto hedge funds could work far better than other strategies. And thereby outperform the market.