The volatility that has become synonymous with the crypto industry hasn’t deterred institutions from participating in it, as hedge funds investing in crypto are at an all-time high, according to PwC’s 2022 Global Crypto Hedge Fund Report.
The annual report surveys both traditional hedge funds and specialist crypto funds to gain a better understanding of how the relatively new, but extremely dynamic sector of the industry functions.
Crypto hedge funds surge in numbers
PwC’s research shows there are over 300 crypto-focused hedge funds currently on the market. While some might attribute this growth to the maturity of the crypto industry, data from the report suggests that the launch of new crypto hedge funds appears to be correlated to the price of Bitcoin (BTC).
Data showed that a large number of funds were launched in 2018, 2020, and 2021 — all very bullish years for Bitcoin — while less bullish years have seen much more moderate activity.
However, most new crypto hedge funds usually employ investment strategies that don’t rely on the market going up. In a survey of over 70 crypto hedge funds, PwC found that almost a third of them employed a market-neutral investing strategy. Aiming to profit regardless of the direction of the market, these funds usually use derivatives to mitigate risk and get more specific exposure to the underlying asset.
The second most popular trading strategy is a quantitative long and short strategy, where funds take both long and short positions based on a quantitative approach. Market-making, arbitrage, and low-latency trading are the most common strategies used. Despite being popular among hedge funds and providing good returns, these strategies restrict funds to only trading more liquid cryptocurrencies.
On a median basis, funds employing a discretionary long and short strategy have been the best-performing ones. PwC’s data showed that these funds showed a median return of 199% in 2021. Looking at the average return shows that discretionary long funds have been the best performing ones, showing returns of 420% in 2021. Market neutral funds considerably underperformed funds with other strategies, showing an average return of just 37%.
PwC notes that returns shown by discretionary long and short funds were the ones employing a strategy that best fits the market at the time, as intra-period Bitcoin returns peaked at 131% last year.
However, with a median performance of 63.4% in 2021, PwC’s sample of hedge funds was only able to slightly outperform Bitcoin’s price, which increased by around 60% throughout the year. And while different strategies yielded different levels of performance, all strategies in 2021 underperformed when compared to 2020.
“The bull market in 2021 did not result in the same level of gains as that of 2020, with BTC increasing just 60% compared to about 305% the year before.”
PwC noted that returns aren’t the only value proposition of hedge funds. What they offer investors is protection against volatility and the data in the report doesn’t paint a picture of whether the strategies were able to offer higher or lower volatility in return to cryptocurrencies. Even with low returns, hedge funds that provide lower volatility could be more attractive to investors.
Assets under management on the rise
Last year’s slow performance and high market volatility certainly haven’t affected the amount of money investors put into hedge funds.
The report estimates that the total assets under management (AuM) of crypto hedge funds increased by 8% to about $4.1 billion in 2021. The median AuM of crypto hedge funds tripled to $24.5 million in 2021 compared to the previous year, while the average AuM increased from $23.5 million in 2020 to $58.6 million in 2021.
Managing all of those assets comes with a cost. Just like traditional hedge funds, crypto funds charge their investors a 2% management and a 20% performance fee.
“One would expect crypto hedge fund managers to be charging higher fees given the lower degree of familiarity with the product and the higher operational complexity such as opening and managing wallets – leading to a less accessible market for individual investors, but it seems this has not been the case.”
PwC expects crypto funds to incur higher costs as the overall crypto market develops. With regulators around the world…