Back in 2017 when the VIX traded in single digits for a record period of time and equity volatility effectively disappeared, daytraders and momentum chasers were desperate for any "exotic" asset that provided at least some daily swings to provide the ability to generate P&L, and as bitcoin broke out in fits and starts, many of them gravitated toward the cryptocurrency whose staggering realized daily vol was just what they needed. Ironically, they all piled in... just as Asian retail traders pulled the rug from below the crypto space, which crashed in early 2018 just as fast as it had risen, leading the massive losses among the ranks of professional investors just as the party was getting started.
One such trader was Doug Greenig, who stopped trading the momentum of the S&P 500 to bet on everything from Malaysian palm oil and Chinese plastic to Colombian interest rates. Today, the founder of $820 million Florin Court Capital trades in some 350 alternative markets - and as he tells Bloomberg, none have felt as wild, lucrative or cutting-edge as Bitcoin. As it soars past $22,000 for the first time, Greenig and a growing number of his peers are trying to exploit systematic rules like momentum, trend-following and price arbitrage in the (re)exploding world of cryptocurrencies.
"It’s the perfect asset for trend models," said the former chief risk officer at AHL, now part of Man Group Plc. "An asset where the fundamental value is harder to pin down may be more capable of generating sustained trends than assets where everyone can quickly agree on what they’re worth." Florin Court, which trades a large number of assets in addition to Bitcoin, is up 0.9% this year, Greenig said.
As we noted previously, according to JPMorgan, CTAs and various momentum-chasing robots have been a force driving the world’s largest digital currency in this record-breaking year. And just like in 2017, they have a reason to jump on board: while the nasdaq is up nearly 40% YTD and the S&P is up a respectable 13%, the SC CTA Index is unchanged for the year, showing that 2020 has been a rather dismal year for trend-followers (as well as most other hedge funds as we will show in a subsequent post).
As Bloomberg notes, the shallow and fragmented liquidity of crypto, and a staggering top-to-bottom trading range of more than 500% this year are proving both a friend and foe to exotic quants seeking to exploit the crypto Wild West, without getting killed by Bitcoin’s famous volatility, which is roughly 4x greater than stocks.
Then again, as we explained up top, this is not the CTAs' first round at the rodeo: the trend-chasing universe tried to trade digital currencies with the kind of systematic methods used in stocks and bonds back in the 2017 mania, but with mixed success especially after the price plunge in early 2018. But now that there is a far greater institutional participation - which is growing by the day more are being drawn in as the crypto world starts to mature as new bitcoin-trading whales appear - and investors from Stan Druckenmiller to Paul Tudor Jones embrace it as a portfolio diversifier, they are giving it another try.
So how are they doing this time? Unfortunately, as Bloomberg notes, data on quant portfolios and the broader industry is scarce, although according to a May report from PricewaterhouseCoopers LLP and Elwood, the most common crypto hedge fund strategy is quantitative, accounting for about half of the $2 billion industry as of 2019.
As in 2017, quants see a big opportunity in theory since their trading rules should apply across assets, based on the belief that humans are prone to behavioral quirks. Trend-following, for example, is built on the notion that humans have a tendency to follow the herd in everything, from single stocks and oil to Bitcoin futures. But while in theory bitcoin may be the perfect momentum assets, in practice it is more difficult.
Just ask Peter Kambolin, who’s run his own quant hedge fund for two decades. As Bloomberg explains, the founder of Systematic Alpha Management started a tiny crypto fund in 2018 that crashed in the market drawdown last year. Now, he only trades a few million dollars of the asset class in managed accounts. When he went all-in on Bitcoin this year, it was based on a judgment call rather than any systematic signals.
“We saw the impact of massive printing of cash by governments around the world and so we made the decision that mostly likely Bitcoin will benefit,” he said from Miami. But he has learned a lesson from the whipsaw in 2018, and Kambolin has now added a mean-reversion signal to his momentum models so that he won’t get whipsawed by sharp reversals.
The draw for institutions - most of which have failed to outperform the S&P for the 10th year in a row - is clear: everyone wants a piece of upside, but none of the downside. Sure enough, amid the recent institutional surge into crypto which can be easily seen by the explosion of bitcoin futures open interest which has put gold far in the rearview mirror...
... more hedge funds are experimenting with strategies like Kambolin’s to protect clients from sell-offs - even if it means failing to match digital assets’ blockbuster returns. Case in point: while Bitcoin has rallied 215% this year, while cryptocurrency hedge funds are up 136% through November, according to a Eurekahedge index; this suggests they are heavily hedged and have missed on nearly half the upside but at least they have far less downside risk.
Cambrian Asset Management, whose executives hail from the likes of Millennium Management and Winton Capital, is also hoping some downside protection will help the firm lure Bitcoin-curious family offices and institutions. To achieve that, Bloomberg writes that its new crypto fund sets a high bar for expanding its wager and a low one for dialing it down, according to co-founder Martin Green. In practice, this means that going into Bitcoin’s 25% slide in March, for example, it was fully hedged.
It worked: the fund with $35 million in AUM is up a staggering 120% this year, generously outperforming all hedge funds which report their results to HSBC.
“We want to be the designated drivers of the party,” Green, a tech executive, said from Mill Valley, California.
Ultimately, in a world where central banks have reduced capital markets to heavily-regulated political tools eliminating much if not all ability to generate alpha, to many quants that left their steady paychecks for the crypto world, the wild ride and market inefficiencies are part of the appeal. That’s the case for Sam Trabucco, a former trader at high-frequency shop Susquehanna International Group, now at crypto trading firm Alameda Research.
At the proprietary trading startup trading up to $2 billion a day, automated programs take advantage of price gaps across exchanges. When data at one exchange gets glitchy, the startup tries to detect that early and make money from those being fooled.
"The crypto markets are more volatile and the platforms are less trustworthy at some level," the 28-year-old Trabucco said from Hong Kong. "There are a lot more low-hanging fruits that exist if you’re strategic." The real draw: those who manage to successfully capture the inefficiencies - at least until the big institutions fully saturate the crypto space - will be able to retire in just a few years.