Poh Hou Sheng, Business and Strategy Associate at Tokenomy looks at the performance of hedge funds so far, and studies the potential of hedge funds in the volatile cryptocurrency market.
Hedge funds in traditional financial markets are struggling. According to Hedge Fund Research (HFR), annual hedge fund returns have fallen to 3% from a high of 18.3% in the 1990s . US $56bn of investments have been withdrawn from funds in the first seven months of 2019, the fastest recorded outflow since 2016 . Increasing competition and changing trading environments are making it harder for hedge funds to deliver. The increased pressure has caused a change in fee structures, with a decrease in management fees, and in certain cases a higher focus on performance fees .
Despite having the worst performing year since 2011, hedge funds managed to beat the S&P 500 index, a first since 2008 . While this victory might be short-lived, it lends credence to arguments positing that hedge funds thrive in volatile environments . According to data from Investment Cache , the S&P 500 is able to consistently outperform active funds only during bull markets, and only after 2009. For market crises since 1990, the S&P 500 suffers way more compared to active strategies. This has led many Hedge Funds to reposition their pitch: their roles are no longer to ensure high returns but to minimize losses during volatile and bearish periods.
The question is, does this trend hold up in the cryptocurrency market?
In the cryptocurrency market, most indexes and funds will compare performances relative to Bitcoin (BTC), which at the time of writing holds a 69.4% dominance of the cryptocurrency market. And 2018 is widely regarded as a devastating year for cryptocurrencies, with BTC returning -72%. In a PwC  study of 100 hedge funds, they found that cryptocurrency hedge funds are able to mitigate losses in comparison to the BTC benchmark, with the median fund returning -46%. Hedge funds using quantitative strategies show the strongest performance, with a positive return of +8% in comparison to fundamental funds (-53%) and discretionary funds (-63%).
Opposite results are seen in 2019 with the market uptrend, with hedge funds unable to outperform BTC during a bull market. Vision Hill Research  reports that bitcoin returned +162.4% for the first 2 quarters of 2019. In comparison, their cryptocurrency fund index (VH-ACI) returned only +66.9%. Fundamental strategies here showed the strongest performance at +81.6% in comparison to opportunistic funds (+65.2%) and quantitative funds (+45.0%).
Despite the stark difference in gains, the ability to preserve capital during bearish periods resulted in a 1,400% performance increase for cryptocurrency funds since December 2016, as compared to a 1,000% increase for Bitcoin according to the Crypto Fund Index (CFI) . Vision Hill reported similar results to CFI and PwC, showing that all active strategies outperformed bitcoin if 2018 data is included, with quantitative strategies showing the strongest performance.
On the other hand, passive indexes and index funds are currently unable to convincingly outperform BTC (see Table 1). This is with the exception of the Bitwise 10 Index, which outperforms BTC if we compare performances from 2017 based on back-tested, hypothetical data. With the exception of the Bloomberg Galaxy Crypto Index which outperformed hedge funds YTD to 30th June 2019, most active strategies are doing better than passive indexes.
Name of Index/Index Fund
|Performance||BTC Performance||Alpha||Comparison Points|
|Bitwise 10 Private Index Fund||-7.3%||25%||-32.3||Since Fund Inception||Link|
|Bitwise 10 Index||-5.2%||25%||-30.2||Since Fund Inception||Link|
|Crypto20||-63.61%||-60.58%||-3.03||Since Fund Inception||Link|
|Bloomberg Galaxy Crypto Index||+126.9%||+189.0%||-62.1||YTD 30/06/2019||Link|
|+0.69%||+59.69%||-59.0||1 year performance||Link|
|Morgan Creek Digital Asset Index||+146.15%||+179.84%||-33.69|
|1 year performance||Link|
Table 1: Passive indexes performance in relative to bitcoin. Data compiled 16th September.
*Data is back-tested to January 01 and does not represent actual returns
Prevailing literature on active asset management in cryptocurrency markets thus seem to corroborate trends in traditional markets: that while active strategies struggle to outperform benchmarks during bull markets, they shine during crisis and volatile markets.
This result should generate interest as the nascent cryptocurrency market is still very volatile (Table 2). High volatility and inefficiencies across trading platforms can provide attractive returns for active strategies, especially for quantitative funds such as arbitrage funds. This, coupled with an increase in institutional services dealing with cryptocurrency across multiple segments such as custody, over-the-counter (OTC) trading and insurance, might be able to court more institutional investors to enter the market.
Table 2: Bitcoin volatility since inception. Source: https://www.buybitcoinworldwide.com/volatility-index/
While current literature seems to support the strength of cryptocurrency funds, one must note that cryptocurrency asset management is still a relatively new service, and there is no guarantee that they can perform in a matured cryptocurrency market. Bitcoin itself is barely a decade old, and hence it is too early to conclude that cryptocurrency hedge funds can truly defeat the market. Investors should also be prudent in due diligence, especially when some hedge funds require long lockup periods and hefty fees. We must also remember that while hedge funds might perform the best during volatile markets, they themselves need to survive that volatile market. As mentioned in the first paragraph, traditional hedge funds are struggling, even if they outperform the S&P 500. Active strategies mitigating losses during bear markets might not translate to high profits for asset managers, especially when losses remain high and investors withdraw their funds. With over 60% of cryptocurrency funds having less than US 10 million in assets under management (AuM) , it is not definite that their business models can survive an extended bear market.
Regardless, current trends for cryptocurrency asset managers are promising. For institutional players looking to get an exposure to cryptocurrency, hedge funds seem to present themselves as a strong entry point.\
References and Further Reading
 Wigglesworth, R., Fortado, L., & Fletcher, L. (2019, January 26). Diminishing returns: hedge funds look to keep it in the family. Retrieved from https://www.ft.com/content/47ba9fdc-201c-11e9-b126-46fc3ad87c65
 Fortado, L. (2019, August 22). Investors pull money from hedge funds at fastest pace since 2016. Retrieved from https://www.ft.com/content/ef090a48-c4f0-11e9-a8e9-296ca66511c9
 Flood, C. (2019, April 1). Hedge fund fee model morphs from ‘two and 20’ to ‘one or 30’. Retrieved from https://www.ft.com/content/7e4e2cdc-8c2a-34d4-a7e2-60c9db9e2a2d
 Fletcher, L. (2019, January 9). Hedge funds suffer worst year since 2011. Retrieved from https://www.ft.com/content/b93e53f0-137f-11e9-a581-4ff78404524e
 Van Der Zwan, M. (2018). Hedge Funds: Opportunties in Shifting and Volatile Markets. Retrieved from https://www.morganstanley.com/im/publication/insights/investment-insights/ii_2019marketoutlookhedgefunds_us.pdf
 Hedge Funds Is Nothing Like S&P 500. (2019, September 2). Retrieved from https://investmentcache.com/hedge-funds-is-nothing-like-sp-500/
 PwC, & Elwood. (2019). 2019 Crypto Hedge Fund Report . Retrieved from https://www.pwc.com/gx/en/financial-services/fintech/assets/pwc-elwood-2019-annual-crypto-hedge-fund-report.pdf
 Vision Hill. (2019, August 15). Vision Hill Crypto Hedge Fund Returns: Second Quarter 2019. Retrieved from https://visionhill.com/wp-content/uploads/2019/08/Q2-2019-Crypto-Hedge-Fund-Report.pdf
 Gnaizda, J. (2019, August 24). Crypto Funds Are Outperforming – You Shouldn’t Be Surprised. Retrieved from https://www.coindesk.com/crypto-funds-are-outperforming-you-shouldnt-be-surprised
 From their sample size, 44% of cryptocurrency hedge funds pursue discretionary strategies, 36% use quant strategies and 19% use fundamental strategies.