Aaro Capital is behind the Aaro DLT Multifund, an institutional quality fund-of-funds designed to capture the investment opportunity in distributed ledger technology (DLT) and crypto-assets. Peter Habermacher, Aaro Capital co-founder and CEO, spent some time with host Paul Gordon to discuss the investment proposition for DLT, the blockchain and crypto-assets. There are four pillars to the DLT Multifund:
- Capture the long-term economic value creation of DLT and crypto assets
- Capitalize on short-term market inefficiencies through arbitrage and tactical trading strategies.
- Capture strategic opportunities as different industries develop and implement DLT applications
- Protect against the high volatility of the asset class using established risk management frameworks
Before joining the crypto revolution, Peter’s background was in competition economics, where he was advising on the competition around large M&A across jurisdictions and industries. He first heard about bitcoin in 2014, but like many others, he dismissed it at the time as a fad with no real economic foundation. Fast forward to 2017 when cryptocurrencies were back in the news, and Ethereum caught his attention.
(1:12) “It was much easier for me to see and understand how this technology could be used in the real world, enabling automation via smart contracts and cutting costs. And this is when we locked ourselves in our offices and did a lot of late-night reading…really drilling down and understanding the technology and the value behind it,” said Peter.
Aaro Capital was born out of pain points that Peter and the other Aaro co-founders experienced when attempting to invest in crypto assets. When the Aaro management team entered the cryptocurrency space in 2017, they were looking to invest their own money. It wasn’t long before they realized the amount of “noise” in the space and that the crypto market moves 10x faster than any traditional market. It isn’t unusual to see market swings of 10% in a single day.
For that reason, they reached out to fund managers to do the investing for them. But they were extremely disappointed with what they found and quickly realized that they were wasting their time with speculators who had very little knowledge about how to run a fund and manage risk.
So they spent two years building a professional way to invest in this space that gives them the comfort that they would like for their own investments. The Aaro team has built a ground-up approach from vast principles focused on how to best explore this opportunity set.
Over the next couple of years, Aaro expects that enterprise DLT will become a standard technology for many different sectors and with a proliferation of use cases. In the very long term, they predict that blockchains like Ethereum and successor platforms, when DLT overcomes its limitations, will become the dominant technologies by blockchain, leading to a very large price appreciation of cryptocurrencies.
In the short-term, their analysis suggests that the cryptocurrency market is currently about halfway through the current bull cycle, according to their own predictors, which have been effective at measuring the market.
On the technical side, they have taken a mainstream economics approach to the space, working alongside top UK universities to understand why this technology should exist and how exactly it adds value using more traditional economic frameworks. They have come to the conclusion that cryptocurrencies are core to the value proposition of blockchain and DLT and the technology’s core proposition is decentralization both for enterprise and non-enterprise use cases for this technology.
(6:43) “So while DLT is the technological innovation, crypto assets are the economic innovation and they go hand in hand. So cryptocurrencies use game theory to align the incentives of participants. And this so far has been the only way we seem to remove the need for a centralized entity to coordinate anything. And this solves a number of key fundamental problems,” said Peter.
Aaro Capital has published a series of whitepapers and thought leadership pieces that are accessible on their website.
Ways to Invest
There is the potential for outsized returns for effective asset management that is an order of magnitude larger than traditional asset classes. According to a recent working paper by Aaro’s economic advisor on the performance of crypto funds, the average monthly bitcoin return is 7% vs. 7.5% for crypto funds. The volatility of crypto funds is 20% lower than bitcoin. The best-diversified fund structure has seen even better results.
(11:00) “However, only a minority of funds can outperform passive crypto benchmarks and produce economically significant value for investors. But importantly for active investors, manager relative performance appears to be persistent over time. And so we are convinced that good manager selection is essential to superior performance,” said Peter.
In terms of a more diversified approach, there are three key advantages to a fund of fund approach to the story of DLT and crypto-assets. First, they provide access to the broad exposure of different active managers specializing in different areas of this space. Second, it provides portfolio diversification across style, strategy and fund structure which can create a good risk/return profile. And the final advantage is expertise.
Aaro splits the DLT and crypto-asset space into four macro buckets based on the returns of different strategies. These are market neutral, long/short, opportunistic and long-term.
On the fund landscape alongside the traditional fund structures, there are also hybrid fund structures that provide VC-style investments but through open-ended hedge fund liquid style structures.
(16:00) “A key aim of DLT and crypto-assets is open finance to allow greater access to investment opportunities and to improve the secondary markets for VC and private equity investments and it is these developments which allow for shorter investment horizons of these hybrid funds relative to traditional VC,” explained Peter.
This universe also extends to mutual funds with a focus on sectors and companies they expect will be able to generate sustained profits from this technology and this asset class over the long term.
On the underlying assets, alongside crypto-assets there are also interesting idiosyncratic opportunities such as mining, staking or yield farming, for example.
Due diligence in the DLT and crypto-assets space is quite different vs. the traditional market. For instance, in the traditional financial markets, you have a large and known universe of established funds on databases. You can easily filter funds by size, length of track records and do quant analysis.
The DLT and crypto space does not have the same luxuries and is more akin to emerging market investing, said Peter. Track records are extremely short, fund sizes are incredibly dispersed and some of the new smaller funds are actually more interesting than the better-known, large established players in the crypto industry.
(18:59) “So we have an approach of ground-up sourcing funds from our extended network as opposed to databases. Due to the increased operational business risk of start-up managers, we have an equal focus on the operational side of things while doing investment and standard quant analysis alongside it. Really one of the most important considerations for investing in the crypto funds space is that operational due diligence is equally as important as investment due diligence,” said Peter.
They must take a much closer look at risk considering the nuances and volatility of the market.
Reporting Requirements & Economic Analysis
Aaro Capital performs very in-depth monthly reporting and monitoring of managers, which is extremely time-consuming, as they attempt to understand the risks they are taking and manage them appropriately, which requires a great deal of expertise.
Aaro believe economic analysis is required to make sense of the complex and quickly evolving landscape. The focus must be on fundamental economic problems being solved, from which you can identify the sectors and use cases where the technology and asset class will generate the most value. Long-term profit generation depends on the competitive landscape at different stages of the value chain.
This approach also considers the timing of the profits. Development is extremely fast in this space, so many new innovations have a relatively short window of opportunity before profits are competed away as others identify them. Being able to identify the lucrative profit generation centres in this space is one of Aaro Capital’s competitive advantages.
Aaro is seeing interest from some large global institutions, among others, including large family offices, intermediaries such as IFAs, multi-family offices and private banks — especially in Southeast Asia — and even public and private pension funds, though it will be a while before they contribute in any meaningful way.
There are still several hurdles for the industry to overcome before becoming mainstream, including regulation, infrastructure development, scalability, user friendliness and accessibility and finally, general acceptance by the public, which is the most unpredictable part, Peter said, as the best technology is not always the one that gets adopted. In addition, there must be the right amount of publicity and PR to bring in the right talent and capital required to overcome the initial high development costs and experimentation.
(29:58) “We believe that the DLT market sufficiently satisfies these requirements to be able to overcome these technological hurdles for mass adoption,” said Peter.