This article explores the aggregate performance of cryptoasset funds since the outbreak of the Covid-19 pandemic. More specifically, we compare the performance of cryptoasset funds against the raw returns of the aggregate stock market and “traditional” hedge funds.
The global health crisis originated by the SARS-CoV-2 virus represents one of the biggest challenges for the global economy since the second World War. Many sectors and industries, from commodities to equities markets have been affected to varying degrees. Interestingly, fuelled by extremely accommodative monetary policy interventions, equity markets have shown strong resilience, perhaps with the only exception being a large drop in valuations at the very beginning of the pandemic.
Despite the short-term relative resilience of financial markets, the medium-to-long term effects of the pandemic are still relatively unknown. Specifically, the large-scale closure of industrial activities, ongoing travel restrictions, the massive increase in sovereign and private debt and consequently of financial risk, in addition to persistent inflation risk, represent serious treats for growth and stability over the coming years.
Naturally, the economic and financial costs of this have great implications for active asset management. Another interesting point is that, although the fundamentals of cryptoassets are not directly linked to economic growth and business cycle conditions, investment strategies and capital flows might be. For instance, risk-off decisions related to aggregate economic prospects can impact risky investments such as cryptoassets even though there is no correlation from a purely fundamental perspective.
Consequently, a growing literature has emerged with the aim of exploring the performance of cryptoasset investments vis-à-vis more traditional active management. In this report, we focus primarily on hedge funds. The rationale is simple, beyond the potential for higher returns, cryptoasset funds possess some comparative advantage over traditional hedge funds. Specifically, cryptoassets are a recent and largely unregulated asset class which creates an investment landscape with a variety of arbitrage opportunities and risk-taking opportunities (see Bianchi and Babiak 2021). Secondly, in contrast to traditional hedge funds, competition across cryptoasset hedge funds is still limited. This limited level of competition, especially from cheaper investment vehicles including Exchange Traded Funds (ETFs), is believed to put less pressure on funds managers to cut costs, increase leverage and to take excess risk. Lastly, the highly fragmented and multi-platform structure of cryptoasset markets have lent credence to the conjecture that they are uncorrelated to other asset classes.
Consequently, this report focuses on comparing cryptoasset funds and traditional hedge funds, specifically the differences in risk and return profiles.
2. Cryptoasset Fund Performance
In this section, we begin by exploring how cryptoasset funds have performed since the initial stages of the COVID-19 outbreak. Then, we investigate the risk-adjusted returns both for a large sample and sub-sample from February 2020 onwards.
Figure 1 shows the compounded returns (1$ initial investment) of the average cryptoasset fund against a buy-and-hold investment in BTC and ETH or a value-weighted portfolio based on the top 100 assets by market capitalisation. The left panel shows the compounded returns for the whole sample from March 2015 to June 2021. The red vertical line indicates February 2020, i.e., the initial stage of the COVID-19 outbreak. The right panel shows compounded returns for the sample starting in February 2020, that is, assuming the initial investment is made right before the outbreak of the COVID-19 pandemic.
Figure 1: Cryptoasset Fund Performance
Source: Aaro Capital Research Notes: The left panel shows the compounded returns (1$ initial investment) of the average cryptoasset fund vs a buy-and-hold in BTC and ETH and a value-weighted portfolio based on the top 100 assets by market capitalisation. The sample starts in March 2021 and ends in June 2021. The right panel shows compounded returns assuming the investment is made right before the outbreak of the COVID-19 pandemic.
When looking at the overall sample from March 2015, the average cryptoasset fund clearly outperforms a buy-and-hold investments in BTC and ETH. Yet, the performance is broadly in-line with the aggregate market. This is a function of two things. First, the decreasing market dominance of BTC and ETH, and the outperformance of smaller cap assets and the DeFi tokens between mid-2020 and early 2021. The massive growth of the DeFi space has been documented by us before. Second, ETH underperformed major altcoins during the 2018-19 period, as highlighted by the relatively low compounded return at the end of the sample. Another important observation is that, when focusing only on the post-COVID period, the average cryptoasset fund performed at par with BTC and underperformed ETH. This somewhat confirms the ample speculation by media and commentators about the decoupling of ETH vs BTC due to the progressive development of ETH towards a Proof-of-Stake protocol.
Figure 1 highlights the boom and bust of cryptoasset prices over the period from the second half of 2020 and early 2021. One may ask if there are significant differences in individual fund performances since the start of the COVID-19 pandemic. Figure 2 provides some highlight. The left panel shows the average returns, the standard deviation and the Sharpe ratio (annualised) of the cross-section of cryptoasset funds for the sample March 2015 to June 2021. The right panel shows the same statistics for the cross-section of funds for the period February 2020 to June 2021
Figure 2: Risk-adjusted Performance
Source: Aaro Capital Research
Notes: The left panel shows the average returns, the standard deviation and the Sharpe ratio (annualised) of the cross-section of cryptoasset funds for the sample March 2015 to June 2021. The right panel shows the same statistics for the cross-section of funds for the period February 2020 to June 2021.
Two facts emerge, when comparing the annualised Sharpe ratio from the whole sample and post COVID-19. First, the average risk-adjusted returns are higher, meaning that even accounting for higher volatility, the performance of funds post-COVID 19 is still higher than by looking at the overall sample, which we should not forget includes the boom and bust across 2017-18. Given the massive drop in market prices in May and June 2021, this seems to be quite remarkable. Second, a higher average Sharpe ratio corresponds with larger cross-sectional dispersion. As a matter of fact, the range of the Sharpe ratios for the overall sample is from -2 to 8 in annualised terms, whereas post-COVID 19 the range is from -5 to 11 in annualised terms. That is, although on average cryptoasset funds are still “in-the-money”, the presence of outlier funds significantly increased.
3. Cryptoasset funds vs Traditional Hedge Funds
At the outset of this article, we outlined how the COVID-19 pandemic has disrupted the economy through massive supply and demand shocks. A growing academic literature has empirically demonstrated that global financial markets have been detrimentally affected by the COVID-19 pandemic with significant contagion effects across different asset classes and sectors.
Figure 3: Cryptoasset Funds vs Traditional Hedge Funds
Source: Aaro Capital Research
Notes: The left panel shows the compounded returns (1$ initial investment) for the average cryptoasset fund and traditional hedge fund from March 2015 to June 2021. The left (right) axis shows the scale of the returns for cryptoasset (hedge) funds. The red vertical line represents the outset of the COVID-19 outbreak. The right panel shows the compounded returns (1$ initial investment) for both the average cryptoasset fund and traditional hedge fund, starting from February 2020 to June 2021.
Figure 3 compares the performance of the average cryptoasset fund and average traditional hedge fund both pre- and post COVID-19 outbreak. The average hedge fund performance is approximated by using the return on the Eurekahedge Hedge Fund Index. This index represents an equally weighted index of more than 2000 constituent funds. The index is designed to provide a broad measure of the performance of all underlying hedge fund managers irrespective of regional mandate.
Two facts emerge. First, the average hedge fund showed strong resilience to the COVID-19 shock in early 2020. This is in line with the aggregate performance of the S&P 500 index. Such resilience is primarily due to extremely accommodative monetary policy across the world. Second, despite the recent significant drop in valuations, the performance of cryptoasset funds is substantially higher than standard hedge funds both pre- (left panel) and post COVID 19 (right panel).
The right panel of Figure 3 shows this case in point. We show the compounded return assuming 1$ initial investment in February 2020 for both the average cryptoasset fund and average traditional hedge fund. On average, traditional hedge funds delivered roughly 20% net return as of June 2021. On the other hand, the average cryptoasset fund delivered a remarkable 350% by the end of the sample. This is including the recent dramatic market correction in May and June 2021.
The large outperformance is also confirmed on a risk-adjusted basis. For instance, the right panel of Figure 2 shows the average Sharpe ratio (annualised) is roughly 2. On the other hand, the Sharpe ratio for the average hedge fund for the period March 2015 – June 2021 has been approximately 0.90 (annualised). This is less than half of the average cryptoasset fund.
There is a relatively large literature that shows how cryptoasset returns are relatively uncorrelated with major asset classes. This is true at the funds level as well. For instance, Bianchi and Babiak (2021) shows how average returns of funds clustered by investment strategy tends to be relatively uncorrelated with the returns on conventional asset classes. Figure 4 shows this may be the case also as far as conventional hedge funds are concerned.
More specifically, the figure shows the scatter plot of the average return on conventional hedge funds and cryptoasset funds, with the fitted value of the regression line super-imposed. Interestingly, the figure shows that there is virtually no correlation, in fact a mild negative correlation between the returns on active management in the cryptoasset space and the returns on conventional hedge funds. To some extent, this confirms and extends the evidence from the existing literature that cryptoasset markets may be exposed to a whole set of different risks and therefore have different price dynamics from standard asset classes (see Bianchi and Babiak 2021 and the references therein).
Figure 4: Correlation between Cryptoasset Funds vs Traditional Hedge Funds
Source: Aaro Capital Research
Notes: This figure shows the scatter plot of the monthly returns on the average cryptoasset fund and the average hedge fund over the sample March 2015 – June 2021. The grey line shows the fitted value of a linear regression model.
COVID-19 has rapidly developed from a major public health issue to a worldwide disaster. This has raised concerns about financial risk from market participants, policy makers and the public at large. In this paper we show three key findings:
- Despite the large market correction in May and June 2021, the performance of cryptoasset funds throughout the pandemic is still largely in positive territory, both in absolute and risk-adjusted terms.
- Cryptoasset funds have significantly outperformed mainstream hedge funds by a significant margin. For instance, taking the post COVID-19 period, the average hedge fund return realised roughly 30% from February 2020 to June 2021. Over the same period, the average cryptoasset fund realised a stunning 350%. This is primarily due to the boom across late 2020 and early 2021.
- There is a non-significant, in fact mildly negative correlation between the performance on cryptoasset funds and more traditional hedge funds.
As a whole, these results offer some interesting perspective on the performance of cryptoasset funds throughout the pandemic. The main takeaway is that the performance of cryptoasset funds, recent drawdown included, is still quite remarkable.