The Crypto Gold Rush: How It Revived The Fund Of Fundsbr>
Following the 2017 crypto boom, investors are once again flocking to an investment many recently abandoned in droves.
The Fund of Funds (FOF) model was on life support when crypto hedge funds began popping up by the hundreds, and investors who do not have the ability or time to due diligence every known strategy have increasingly looked to asset managers who have done the legwork and have the relationships to access the best funds —even those that have stopped accepting new investors.
FOF managers are basically talent directors, they know the best firms – new or old. They build relationships, pour over monthly reports and crunch numbers to understand strategies in depth. The knock on them, though, has always been that they only layer fees on top of fees in order to make money for doing little in terms of actual investing. FOF managers typically earn fees on top of the management fees they pay their managers – in most FOF strategies, those fees are normally one&10 (one percent management and 10 percent of performance).
These fees on fees have caused institutional LP’s to reconsider FOFs over the last few years in many strategies. Just this past year alone a composite measure of traditional hedge-fund performance is down 1.66% year-to-date, the worst performance in the first 10 months of a year since 2011, representing the ugliest losses for the industry since 2008, according to data from Hedge Fund Research.
This negative sentiment and the flight to low-fee exchange traded funds (ETFs) and other strategies eventually caught up with FOF managers in the traditional asset space. The resulting exodus drove almost all of them out of business.
The crypto dawn brought a wave of initial coin offerings (ICOs), security token offerings (STOs), the Simple Agreement for Future Tokens (SAFT), and also Bitcoin, Ethereum, Litecoin and more than a thousand other digital assets trading across dozens of unregulated exchanges based in far off places like Malta, Hong Kong, Taiwan and elsewhere. Investors saw an opportunity but did not understand what those names meant, where the gains were coming from or how to take advantage. The need for an expert became clear.
Crypto is a relatively new asset class – Bitcoin is only 10 years old. There is “information asymmetry” and a majority of Institutional Investors run into “bandwidth issues” i.e. they have a lot on their collective plate and don’t have much time to study a completely new asset class that aims to fundamentally shift the way we think of money, identity and much more. Another issue many investors run into with a relatively new asset class is the lack of relationships and access.
Many of those same investors are beginning to show interest in crypto as we saw late last year with Yale Endowment investing in Paradigm and a16z crypto. However, with approximately 500 funds created in the last 2-3 years an Institutional Investor may struggle to find the right one for their firm.
Rick Marini, who heads up Protocol Ventures, a crypto fund of funds, recently told me that not many funds have broken thru the brand side — they aren’t household names; there’s no clear winners. LP’s don’t know who the top funds are in this asset class right now.”
There are a lot of new managers in this nascent asset class. There is no clear favorite that investors large and small recognize right now.
For an Institutional Investor looking to access digital asset opportunities, there are some issues that face them right away that include selection risk, a lack of historical return data and the wave of stories detailing the funds closing up shop after less than a year as the crypto winter set in. There’s also a lack of brand recognition.
That said, there’s clearly been a lot of energy and business building in crypto for the past few years. With that, the asset class has a lot of new managers, many of who are running their first fund, some of whom have run into some operational issues and some who are running great funds but don’t have the broad-based name brand recognition of a Ray Dalio or a Cliff Asness. In time, I am confident that will change as some funds rise to the top and become leaders in the space.
We are also seeing more differentiated strategies being created today compared to the first funds dating back to 2015, which I believe is a net positive; more diversification within the asset class and specialization is appreciated by institutional investors. All of this has led to a rebirth of the fund of fund model, where a FoF manager can spend the time, find the specialized managers, create a diversified bucket and give investors exposure to the asset class that they themselves wouldn’t have bandwidth and access to find.