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November 21, 2024
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Hedge Funds

Three opportunities from Coinbase’s Crypto Hedge Fund Report


Crypto hedge funds have done rather well these past few years, with many clocking exceptional results. And with better regulation and security, these funds are becoming more popular with big-money investors. Coinbase’s 2024 Allocator’s Guide To Digital Asset Hedge Funds explains the ins and outs of crypto investing and the benefits it may bring. Here are three important takeaways from the report and the potential opportunity in each.

1. Active management is king in crypto.

Most stock investors have a hard time consistently beating the market – that’s why many opt for “passive” ETFs that simply track an index like the S&P 500. But “active” hedge fund strategies seem to have a better hit rate in crypto. Digital asset hedge funds performed better than bitcoin (the de-facto crypto index) from 2017 to 2023, according to the report. The Preqin Cryptocurrency Hedge Funds Index (blue, in the chart) puts the yearly returns of your average crypto hedge fund at around 80% over that time – about 8% higher than bitcoin’s (yellow). And the index did that with less volatility, too.

The Preqin Cryptocurrency Hedge Funds Index tracks the performance of over 1,000 crypto hedge funds. It has achieved higher yearly returns on average than bitcoin, with less volatility. Sources: Preqin Pro, Factset.

The Preqin Cryptocurrency Hedge Funds Index tracks the performance of over 1,000 crypto hedge funds. It has achieved higher yearly returns on average than bitcoin, with less volatility. Sources: Preqin Pro, Factset.

These results ring true to me. After all, crypto is still a new asset class with a less efficient market – meaning it’s full of opportunities for pros to find hidden gems and profit from major price swings. Unlike the stock market, where passive investing often works best, crypto’s wild nature means active strategies can really shine. In fact, here are a few strategies that crypto hedge funds already use:

  • Quant active funds use algorithms and data to spot trends and profit from market inefficiencies.
  • Market-neutral funds try to make money by combining long (buy) and short (sell) positions – without betting on the market’s direction.
  • Long-only funds generally stay invested in digital assets, believing prices will rise over time. They’ll carefully research tokens and coins, and might move some crypto into cash when things get volatile.
  • Multi-strategy funds mix it up with different tactics, like long-only and market-neutral, to spread risk and tap into multiple profit streams. They might invest in other digital asset funds (fund of funds).

As the chart below shows, “quant active” (orange) and “multi-strat” (green) funds have made the most money for investors since 2018.

Since 2018, some crypto hedge fund strategies beat bitcoin and crypto long only. Source: Penguin Pro.

Since 2018, some crypto hedge fund strategies beat bitcoin and crypto long only. Source: Penguin Pro.

So, what’s the opportunity? Digital asset hedge funds can be a good fit for accredited investors, but sadly, they’re out of reach for most retail investors. That said, simply holding bitcoin (pink, chart above) has outperformed the average long-only crypto fund (dark blue) over the past four years. Plus, the report points out that avoiding big losses is arguably the most important factor for long-term success – and that’s something any crypto investor can focus on. Check out this piece on how to play crypto defense to learn how to do that.

2. A little bit of crypto goes a long way.

The report says that adding a small amount of crypto over three to five years can boost portfolio growth – while keeping overall risk and volatility in check. It shows the effects of adding between 1% and 5% of the Coinbase Core Index to a typical 60% stocks and 40% bonds portfolio from 2019 (see table below). That Coinbase Core usually contains around 70% bitcoin, 20% ether, and the rest in other “blue chip” projects like Solana and Cardano. And the stats in the table do involve quarterly rebalancing of each portfolio back to its original percentages (essentially, selling some of the winners to buy more of the losers).

Each 60/40 portfolio holds 60% in stocks (iShares MSCI ACWI ETF) and 40% in bonds (iShares Core U.S. Aggregate Bond ETF). Sources: Yahoo Finance and Coinbase.

Each 60/40 portfolio holds 60% in stocks (iShares MSCI ACWI ETF) and 40% in bonds (iShares Core U.S. Aggregate Bond ETF). Sources: Yahoo Finance and Coinbase.

Now, the annual returns (in green) increased by adding more crypto – and that’s not surprising, given its general price rise since 2019. But don’t forget, these numbers include two 70%-plus crypto bear markets: one from June 2019 to March 2020, and another from November 2021 to November 2022. You’d think that might dramatically raise the volatility (orange) as you add more crypto to each portfolio. But because of that quarterly rebalancing, the portfolios tend not to get too crypto top-heavy at any point, so the volatility doesn’t jump that much. It also has kept the max drawdown (worst-case loss from top to bottom, dark blue) to a reasonable keel. As for getting more bang for your risk buck, adding some crypto could make sense: the Sharpe ratio (yellow), which measures yearly return over volatility, increased with more in Coinbase Core. Besides, digital asset volatility has been trending lower anyway, according to the report.

So, what’s the opportunity? You could consider adding a small amount of bitcoin, ether, and other blue chip projects to your portfolio if you want to (potentially) increase its growth over time. Just be sure to rebalance occasionally to help protect your downside.

3. Crypto isn’t that correlated with stocks.

The general word on the street is that bitcoin (and by extension, crypto) trades like a high-growth tech stock – and it’s basically a leveraged bet on the Nasdaq. And sure, there have been times when that theory has held up. But according to the report, crypto dances to its own tune every now and then.

See, a “correlation coefficient” of 1 between two investments means they move in sync – and therefore, there’s no point owning both from a diversification perspective. But bitcoin and ether’s one-year correlations with US stocks (S&P 500) were just 0.42 and 0.44, respectively, as of June. In other words, there are potential diversification benefits in holding a bit of crypto with your stocks. And these correlations were even lower (i.e., better) with other asset types like bonds, gold, copper, silver, and the US dollar index (DXY).

Bitcoin and ether have recently had relatively low correlations vs. other asset classes. Sources: Bloomberg and Coinbase.

Bitcoin and ether have recently had relatively low correlations vs. other asset classes. Sources: Bloomberg and Coinbase.

So, what’s the opportunity? Well, since crypto doesn’t always move with stocks and other traditional investments, it might make a good addition to your portfolio.

Here’s Coinbase’s full hedge fund report if you want to dig deeper.



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