With about 800 crypto funds relying on a new asset class, which has its own properties, it is essential to assess them through an appropriate framework. We provide a basic framework of useful metrics to assess the true risk of a crypto fund as a quantitative screening tool. Short-listed funds can then be assessed in more detail through a classic due diligence process.
Assessing the return/risk profile of a directional trading crypto fund
Assessing the expected return of a directional fund
Investors in a directional fund should first have a clear understanding of the dynamic of the fund’s overall strategy in order to realize where the performance will come from and over what period before assessing whether the risk taken to achieve such results is worth it. This is achieved through discussions with the fund manager.
Warning: If a fund manager refuses to explain any of the fund’s strategies, beware!
When asking about a fund’s strategies, a truthful and experienced manager should be able to explain it in plain English. If a fund manager doesn’t want to disclose anything stating that it’s a trade secret, you could still try to understand what the fund tries to achieve by analyzing its past track record. However, in such a case, it’s unlikely that the manager will provide daily returns of the strategy for a more granular analysis, which may thus be worthless.
A transparent fund manager inspires trust, a secretive one inspires defiance, but even if a manager is transparent about strategy, investors should verify that these pitches from fund managers are credible and not take their word for granted. The Bernie Madoff Ponzi scheme was just that. Madoff explained that he was trading S&P 100 options as the basis of his strategy. Why not? But given the size of this specific market (~$100 million daily on average), there was no way he could have been trading the size of his fund ($6 billion), but he still lured many naïve investors.
Understanding the fundamentals of the strategy
Directional funds try to achieve their goals in different ways, and investors have to understand in which market environments they are going to perform well or not; some funds may perform very well during smooth trending markets but can be crushed during times of high volatility, whereas funds performing well during hectic markets can dramatically underperform in strong trending markets.
No single strategy can perform well in every market environment, as each strategy is designed to only fully capture specific moves and avoid being crushed otherwise. Directional funds tend to embed different strategies, each designed to capture specific market moves; but since these strategies are usually blended together, the resulting blend should perform well during most market environments, but will always underperform the best single strategy in a given market environment.
Understanding the strategy timeframe
Understanding the timeframe through which a fund strategy works — i.e.,…