cryptoknowmics.com
A traditional hedge fund is a good choice for risk-averse investors as its founder and team of analysts are known to guide their clients' money in the right direction. Due to the rapid emergence and evolution of cryptocurrencies, the traditional hedge fund industry has become the ideal entry point for investors. Large, influential funds have started to see Bitcoin as a relatively small-quantity asset and have begun taking advantage of its demand. Despite the crypto community's widespread criticism and dismaying statements, returns from these funds have been impressive. However, long-term crypto investors should think twice before investing in crypto hedge funds. Here's why:
Hedge Funds Lack Transparency
A hedge fund can be very appealing to individuals looking for higher returns. However, it can also become riskier for investors with less regulation due to the lack of transparency. Also, with less transparency, investors can be left with the impression that the funds are in proper use, which is not always the case. In recent years, there have been several cases where hedge fund managers have been accused of using their clients' money for various non-investments. Mostly, the clients do not receive their money when the cryptocurrency trading rules do not go as planned. Another common perception is that the managers of hedge funds are not subjected to the same scrutiny and registration requirements as other financial firms. It could expose them to various fraud activities and potential conflicts of interest. Due to the various scandals in the past few years, the US and European authorities have been pushing for more transparency in hedge funds. They also encourage investors to provide more information about the firms' valuation methodology and leverage exposure. However, as this is yet to take effect and the lack of transparency still transpires, you want to keep it off as a long-term investor.
Lack of Diversity
Crypto hedge funds often allow investors to only invest in one coin or one type of investment. When this happens, investors cannot diversify their portfolios and have access to funds from other investment types that would have probably made more profit, thereby, limiting them. Crypto hedge funds also have a concentration risk whereby they excessively focus on a particular investment strategy or one sector because of the speculation of high returns. Different investors have different expectations regarding the diversification of funds. For instance, some investors expect to benefit from the diversification of funds, while others see it as a risk. If the various macroeconomic conditions are unfavorable, including rising inflation, lower consumer spending, and high input costs, the entire sector, say Bitcoin, will likely experience a downward spiral. Since the fund manager has put all of the eggs in one basket, Bitcoin's performance will be directly proportional to that of the entire fund. However, if the fund manager has diversified the fund's assets into various sectors, then the crashing of the sector can be neutralized by the other investment sectors.
Hedge Funds are Likely to Make your Crypto Investments Feel like Fiat
The charm of the hedge fund industry has reportedly declined since the 2008 financial crisis. Various factors such as interest rate changes, credit spreads, and government intervention have created hurdles that prevent experienced fund managers from taking advantage of their opportunities. According to many seasoned traders and investors, traditional strategies can be utilized in the crypto market. For instance, quantitative funds are developing systems that can predict future moves in the market using historical data. These funds use various techniques such as pattern recognition and price trends. Clearly, if the same strategies are used, it sure feels like your crypto investments are treated as fiat. Due to the nature of the partnership structure, hedge funds are generally taxed as a limited liability company. It ensures that the investors are not liable for double taxation. However, this can be detrimental to the investors as the fund's general partner will determine the distribution of the profits and losses. Furthermore, investors still bear tax liabilities.
Susceptible to Huge Losses?
The rise of crypto-focused hedge funds has attracted investors due to the promise of significant returns compared to the lack of negative yields on bonds or cash. Last year, bitcoin was one of the best-performing assets, rising 36 percent compared with the S&P 500's 8 percent decline. Although the price discrepancies between different assets on different exchanges have long been an issue in the bond and stock markets, traders can also use them to make money in the crypto market. Unfortunately, achieving the returns that crypto-focused investors have been promising has often proved difficult. On March 12, the price of bitcoin dropped by almost 40 percent, which led to the closure of several funds.
Final Thoughts
Most opportunistic hedge fund managers are now investing a small portion of their funds in cryptocurrencies, mainly through bitcoin and ether options and futures. These managers typically operate relative-value and multi-strategy funds. Several managers of pure-play cryptocurrencies are seeing increasing interest from investors. Although the asset class is still relatively unregulated, some experts believe it could eventually become a more prevalent asset class. Despite the increasing interest from investors, most hedge fund managers are still focused on education instead of investment returns due to cryptos being in their infancy. Notably, crypto investors should be prepared in case of anything when they go into crypto hedge funds.