Market Neutral Was the Favorite Strategy Among Crypto Hedge Funds, but It Did the Worst

Hedge funds and their investors continue to adopt cryptocurrencies for their portfolios. In its annual Global Crypto Hedge Fund Report, PwC, in partnership with Elwood and the Alternative Investment Management Association (AIMA), reports that last year brought growing assets under management at crypto hedge funds and acceptance of digital assets among traditional hedge funds.

The survey covered the results of research conducted by CoinShares in the first quarter combined with PwC's "qualitative inputs on sound practices observed within the crypto hedge fund space."

Crypto hedge fund launches rise with the bitcoin price

Based on the results of the research, PwC estimates that more than 300 crypto hedge funds may be in existence right now, and half of them were launched within the last three years. The firm added that the launches of new crypto hedge funds appeared correlated with the price of bitcoin.

For example, a large number of funds were launched in 2018, 2020 and 2021, when the bitcoin price was rising. On the other hand, fewer funds were launched during less bullish years. However, PwC warned that this analysis might be partially hindered by survivorship bias because funds launched between 2014 and 2017 may no longer be in operation and thus wouldn't have responded to the survey.

Last year, the total assets under management by crypto hedge funds rose 8% to about $4.1 billion. The median AUM tripled in 2021 to $24.5 million versus $8.5 million in 2020. Individual crypto hedge funds grew by an average of 150% last year, with the average AUM among crypto hedge funds rising from $23.5 million to $58.6 million.

PwC also found that the percentage of crypto hedge funds with over $20 million in assets under management increased last year to 59% from 46% in 2020. The firm noted that this was significant because $20 million is the threshold for "critical mass" in the world of traditional hedge funds.

Strategies employed

PwC classified the strategies utilized by crypto hedge funds into six types: discretionary long-only, discretionary long/ short, quantitative long/ short, quantitative long-only, market neutral, and multi-strategy and others. The strategies differed by investment horizon and the types of investments they made, among other factors.

For example, discretionary long-only funds tend to have a longer investment horizon and invest in early-stage token and coin projects while buying and holding more liquid cryptocurrencies. On the other hand, discretionary long/ short funds covered a wide range of strategies from long/ short to relative value, event-driven, technical analysis, and crypto-specific strategies.

PwC found the most common crypto hedge fund strategy to be market neutral, a new category for this year's survey that aims to profit regardless of the market's direction. These funds tend to use derivatives to mitigate or eliminate broader market risk and get more specific exposure to underlying cryptocurrencies.

The firm reported that 30% of the crypto hedge funds surveyed fell into that category. Quantitative long/ short was the second-most common strategy among crypto hedge funds, followed by discretionary long-only and discretionary long/ short. Quant long/ short included funds that approach the market directionally and quantitatively through strategies such as market-making, arbitrage and low-latency trading.

Performance by strategy

According to PwC, discretionary long/ short crypto funds recorded the best median performance at 199%, followed by discretionary long-only at 176% and quant long-only at 109%. The worst-performing strategy on a median basis was market neutral with a 26% median return. Overall, the median performance of all crypto hedge funds reporting to CoinShares in the first quarter was 63.4% in 2021, a slight outperformance of bitcoin's 60% increase.

However, discretionary long-only crypto funds had the best average performance at 420%, followed by discretionary long/ short at 228% and quant long-only at 120%. The worst-performing strategy on an average basis was again market neutral at 37%.  

The survey also found a significant increase in the proportion of funds trading derivatives, from 56% in 2020 to 69% last year. Additionally, 41.6% of crypto hedge funds utilized decentralized finance platforms to enhance their yield through farming or borrowing and lending of assets. Meanwhile, 78% of crypto hedge funds had invested in the DeFi sector.

Predictions

PwC found that 42% of crypto hedge funds predicted that the bitcoin price would rise to between $75,000 and $100,000. Another 35% predicted a price of $50,000 to $75,000 by the end of this year.

Given that the report was released in June, bitcoin has significant ground to make up before it will come anywhere close to the low end of that range. PwC added that due to the time of its survey and results, crypto funds were still trading TerraUSD and Luna.

In fact, almost 30% of crypto hedge funds had traded Terra, while 50% had some form of exposure to Luna. As a result, PwC noted that it's unclear how the events involving Terra, Luna and the wider market disruptions in May will have impacted crypto hedge funds by the end of this year.

Looking at the cryptocurrencies hedge funds invested in the most, it comes as no surprise that bitcoin and ether took the number one and two spots, respectively. After those two coins, the top five altcoins among crypto hedge funds were Solana, Polkadot, Terra/ Luna, Avalanche, and Uniswap. PwC expects that capital flows into various cryptocurrencies could slow the rest of this year amid increasing caution among investors.

The preferred stablecoin for crypto hedge funds was Circle's USD Coin, followed by Tether, at 73% and 69% of funds, respectively.