Research

Since 2013, a new breed of actively managed crypto-currency alternative funds has been coming to the fore. Initially starting off with dedicated exposure to bitcoins, these funds have now diversified across the breadth of crypto-currencies and consistently rank at the top of performance tables thanks to the skyrocketing price of crypto-currencies over the past few years.

Figure 1 below 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 tracks the performance of five actively managed ‘Alternative-Coin’ funds that carry exposure to Bitcoin, Ethereum and other crypto-currencies. 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 while minimising losses on the downside to maximise returns to the crypto-currency strategy from actively timing the market.

Over the 46-month period shown below starting as of end-June 2013, the Eurekahedge Crypto-Currency Fund Index has returned a cumulative of 2152.32% in contrast to a return of 1408.11% for the Bitcoin Price Index. On an annualised basis, this comes to 125.35% for actively managed crypto-currency strategies versus 102.96% 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 213.11% compared with 237.72% for the Bitcoin Price Index. Unsurprisingly, the crypto-currency funds rank among the top most volatile hedge fund strategies as tracked in the Eurekahedge Global Hedge Funds Database.

Figure 1: Eurekahedge Crypto-Currency Fund Index vs. 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. Crypto-currency funds have also outperformed the Bitcoin Price Index between 2H 2013 and 2015; though lagging behind in 2016 and 2017 April year-to-date. 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 capitalised on to deliver outsized returns relative to the underlying.
3. Over both the three and two year annualised period, crypto-currency funds have outperformed their peers delivering annualised gains of 56.30% and 146.58% 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 73% of its value from its 2013 high. In contrast the Bitcoin Price Index lost almost 81% of its value.

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). With regards to hedge fund strategies, the MSCI and S&P GS Precious Metals, the correlations are not statistically significant over the 46 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

Figure 2 below 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 12.68% while crypto-currency funds recorded a loss of 9.25%. Similarly when the Bitcoin Price Index ended in the green – the average gain amounted to 36.09% while that for crypto-currency funds came in at 32.64%.

Figure 2: Monthly returns for crypto-currency funds and relative performance

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$200 million. 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 0.60% at the expense of 0.17% increase in annualized volatility, resulting in an overall improvement in the Sharpe ratio from 1.49 to 1.63. 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, fortune is favouring the brave early ventures, or the reckless as many may see them.

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