Research

Crypto-currency funds dominated the hedge fund performance league tables back in 2017, thanks largely in part to the gravity defying price of Bitcoin (BTC), Ethereum (ETH), and other major crypto-currencies. The Eurekahedge Crypto-Currency Hedge Fund Index returned 1708.50% throughout the year, outperforming the global hedge fund industry average performance by over two hundredfold. While opinions around the future of crypto-currency became increasingly polarized, the enviable price appreciation continued to attract actively managed funds investing in crypto-currencies.

Shortly after the start of 2017, Bitcoin price broke the US$1,000 barrier for the first time in three years, bringing it close to its previous peak price in 2014. Since then Bitcoin rallied at an incredible rate throughout the rest of 2017, despite seeing noticeable dips all over the place. It broke the US$2,500 mark around the end of May, the US$5,000 mark in October, and the US$10,000 mark in early December. The coin price peaked at over US$19,000 in mid-December following the launches of the CBOE and CME Bitcoin futures, before slowing down throughout the rest of the month and ending the year at just below US$14,000. The year 2017 also saw the meteoric rise of several crypto-currencies, such as Ethereum, which gained 10,007.02% return over the year, as well as the birth of several new crypto-currencies, such as Bitcoin Cash (BCH), which resulted from a split of Bitcoin. Another type of crypto-currency called stable coins also gained popularity by offering price stability, which was achieved by pegging the currency to stable assets such as fiat currency or gold. Going into 2018, the crypto-currency market saw a major selloff triggered by regulatory challenges in South Korea and the hacking of Coincheck, the largest crypto-currency OTC market in Japan, which saw Bitcoin price slump below US$7,000 in early February, which happened to coincide with the volatility crisis which saw the CBOE VIX index surge twofold overnight. The listing of CBOE and CME Bitcoin futures allowed investors to short Bitcoin on a large scale, and might have contributed to exacerbate the selloff. As of August 2018, Bitcoin was down 49.39% year-to-date, while Ethereum and Bitcoin Cash were down 61.75% and 79.63% respectively.

Figure 1 compares the performance of the Eurekahedge Crypto-Currency Hedge Fund Index against the Bitcoin closing price and the performance of a passive portfolio constructed by allocating 80% into Bitcoin and 20% into Ethereum by the end of 2015.¹

Figure 1: Performance of crypto-currency hedge funds against comparable benchmarks since the end of 2015

As observed in Figure 1, crypto-currency hedge funds and Bitcoin trailed behind the passive portfolio of Bitcoin and Ethereum by a significant margin. The performance of Ethereum in 2017 was on a different order of magnitude from the performance of Bitcoin over the same year, thus explaining how the addition of 20% Ethereum into the mix drove the portfolio return by such a massive scale.

Source: Eurekahedge

Table 1 provides the detailed risk return statistics of the Eurekahedge Crypto-Currency Hedge Fund Index and comparable benchmarks, including Bitcoin, Ethereum, and the passive portfolio shown in Figure 1. Key takeaways include:

1. The Eurekahedge Crypto-Currency Hedge Fund Index returned 1708.50% in 2017, supported by the soaring prices of crypto asset classes throughout the year. The index lost more than half of its value over the first eight months of 2018, as fund managers struggled to mitigate the damage caused by the crypto-currency market crash. Over the same period, Bitcoin and Ethereum lost 49.39% and 61.75% of their values respectively.
2. Over the period starting from the end of 2015, crypto-currency hedge funds generated an annualised return of 187.20%, which is marginally better than the 184.88% annualised return generated by Bitcoin. In terms of risk-adjusted returns, crypto-currency hedge fund managers generated a Sharpe ratio of 1.99, trailing behind Bitcoin and Ethereum which generated 2.05 and 3.03 Sharpe ratios respectively.
3. The passive portfolio consisting of 80% Bitcoin and 20% Ethereum as of December 2015 naturally generated a risk return portfolio which lies between those of Bitcoin and Ethereum. The portfolio generated an annualised return of 414.97% and a Sharpe ratio of 2.43.

Table 2 provides the correlation values between the performances of crypto-currency hedge fund managers against the benchmarks. As seen in the table below, among the three benchmarks, Bitcoin has the highest correlation coefficient to the Eurekahedge Crypto-Currency Hedge Fund Index, which is not entirely unexpected as Bitcoin was by far the crypto asset that commanded the largest market share since its inception almost a decade ago. The rise of altcoins – crypto-currencies other than Bitcoin – has brought about a subclass of crypto-currency hedge funds which focus their trading strategies around these altcoins, but an overwhelming majority of the fund managers in this space still have moderate to significant exposure to Bitcoin.

Table 2: Correlation matrix

Source: Eurekahedge

Figure 2 provides the 12-months rolling alpha of the Eurekahedge Crypto-Currency Hedge Fund Index against the three benchmarks, assuming a risk-free rate of 0%. As seen in the figure, crypto-currency hedge funds managed to generate positive alpha against all benchmarks throughout most of the period shown in the chart. Over the period starting from the end of 2015, crypto-currency hedge fund managers generated 1.36% alpha against Bitcoin, 6.20% alpha against Ethereum, and 2.93% alpha against the custom portfolio described earlier. The reason for the fund managers’ enormous alpha against Ethereum despite their underperformance is their low beta – and hence low systematic exposure against this crypto asset class. The Eurekahedge Crypto-Currency Hedge Fund Index posted a beta of 0.17 against Ethereum, in contrast to the 0.90 beta against Bitcoin over the same period.

Figure 2: 12-months rolling Alpha of crypto-currency hedge funds vs comparable benchmarks (RFR = 0%)

Figure 3 shows the outperformance of the Eurekahedge Crypto-Currency Hedge Fund Index constituents over a passive portfolio of 80% Bitcoin and 20% Ethereum constructed at the end of 2015, as well as the monthly returns of the portfolio. We can observe that throughout the period below, the number of constituent funds outperforming the portfolio is inversely related to the performance of the portfolio – when the portfolio generates a positive monthly return, most of the crypto-currency hedge fund managers were typically unable to capture the entire upside of the underlying assets. On the other hand when the portfolio is down for the month, hedge fund managers were able to provide some downside protection and outperform the passive portfolio.

Figure 3: Outperformance of crypto-currency hedge funds against a passive portfolio of 80% BTC and 20% ETH

Investing in crypto assets surely comes with its challenges, together with the potentially exceptional gains. Apart from varying regulations across countries and concerns regarding the legitimacy of the asset class in particular countries, the incorporation of crypto-currency assets into an investor’s portfolio comes with significant risks, as exhibited by the sharp losses posted by the Eurekahedge Crypto-Currency Hedge Fund Index throughout the first eight months of 2018. While expert opinions regarding crypto assets remain heavily antithetical between those who are pro and against crypto-currencies, it is undeniable that the high volatilities of the asset class provides ample opportunities for investors who are able to stomach the risk to generate significant returns, regardless of whether they are betting on the long side or the short side of the coins.

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