Asian Institutions Are Finally Warming to Crypto Hedge Funds

The Takeaway:

• Asian institutional investors, mostly high-net-worth individuals and family offices, are increasingly showing interest in digital assets, with some having allocated part of their portfolios to crypto hedge funds.
• The gloomy macroeconomic outlook and the news of Facebook’s Libra and China’s central bank digital currency have fueled this interest, market participants say.
• Crypto hedge funds in the region face hurdles to getting off the ground, including licensing, banking, custody and insurance.

Asian institutional investors, mostly high-net-worth individuals and family offices unfamiliar with digital assets, are increasingly showing interest in allocating a small portion of their portfolios to crypto hedge funds.

Unlike in the past, some have actually taken the plunge and made such allocations, while more are likely to follow, industry experts say.

The rub is that, like in other parts of the world, a crypto-averse banking sector and regulatory requirements pose high hurdles to launching such funds, and hence wider institutional adoption, in Asia.

This year has been a crucial turning point for BBShares, a Hong Kong-based crypto hedge fund catering to institutional investors in Asia. The firm is on track to reach committed capital of $10 million before year-end, mostly from high-net-worth individuals and family offices, while traditional financial institutions remain on the sidelines.

Most of the capital came in during the past four months after news of Facebook's Libra project and bitcoin’s bull run since early this year piqued investors’ interest.

"The pace of [institutional] investor allocation to crypto this year has been much faster,” said Jett Li, chief investment officer at BBShares who formerly worked at Bank of New York Mellon. "Demand for secure and efficient institutional asset allocation into crypto is quite strong."

Tiantian Kullander, co-founder of Asian crypto trading firm Amber Group, echoed that sentiment.

"The interests are definitely there," he said. "The frequency [of institutional investors inquiring about crypto investments] is increasing noticeably in recent months."

That said, the number of crypto hedge funds located in Asia is still small. Around five percent of global crypto hedge funds are located in Singapore, compared to 64 percent in the United States, according to a 2019 research report by consulting firm PwC.

These funds are structured much like traditional hedge funds, leveraging strategies such as quantitative trading, arbitrage, long-only and long-short, and aiming to generate alpha, or above-market returns, for institutional investors.

Free advertising

A number of market participants noticed significant pickup in investor interest in crypto after Facebook formally announced in June that it plans to launch Libra.

"It is the best advertising you can hope for crypto," said Jianbo Wang, chief investment officer of CYBEX, a decentralized crypto-asset exchange. "After the Libra announcement, people feel like they have to look into investing in the space."

If Libra is the perfect advertisement, the increasingly plausible reports about People's Bank of China's (PBoC) planned digital currency serve as an official blessing.

In August alone, the Chinese central bank made several public comments on its planned digital yuan, which could be the world's first. Underscoring the seriousness of the project, a dedicated team has been developing the system in a separate office with restricted access since earlier this year.

Beyond the two immediate catalysts, several macro factors could also be shoring up investor interest. Bitcoin’s price has jumped 120 percent year-to-date in 2019 – the best-performing asset in 2019 so far by a massive margin.

To put this in perspective, some of the best-performing assets in 2019 so far include the U.S. real estate index (measured by MSCI REIT Index) and U.S. equities (measured by the Russell 3000 index) – both are up around 20 percent, according to data from SeekingAlpha.

Bitcoin’s outsized returns are giving investors a case of FOMO, fear of missing out. Negative interest rates in Europe and a gloomy economic outlook worldwide make an allocation in crypto – viewed as an uncorrelated asset, unaffected by swings in traditional markets – much more appealing.

"The downward trend in the macro environment has contributed to investor interests. People's eyes are opened a bit more toward crypto," said Ryan Rabaglia, head of trading at OSL Brokerage, a digital asset brokerage firm in Hong Kong. "There is definitely a sense of awakening to crypto as investors are battered with all kinds of 'wars' and problems around the world."

Belt and road

To be sure, the road to wider institutional adoption for crypto asset trading may be a rocky one in Asia.

Even after investors decide to allocate assets to crypto, there is a myriad of challenges for actually deploying the capital.

Options are limited, especially in Asia. Investors can either purchase crypto assets directly or do so via a trustee, said Kenneth Xu, CEO of Hong Kong-registered crypto custodian InVault Trust.

But more sophisticated and versatile products are needed to provide alpha-generating returns beyond just a one-way bet. Providing that optionality, by setting up a crypto trading fund that can take money from accredited and institutional investors, is no simple feat.

The most basic investment fund services such as opening a bank account, fund administration, custodian service, insurance coverage, and auditing are difficult to obtain or simply unavailable to crypto fund managers in Asia.

Opening a bank account for a crypto investment management company in China is almost impossible, given regulatory and foreign exchange constraints. Meanwhile, banks in Hong Kong and Singapore are in general unfriendly toward this type of accounts due to perceived risks related to crypto investment.

BBShares said it took well over a year to get everything ready. It turned to a U.S. custodian to provide custody and insurance coverage for its funds and created an in-house asset management system to meet compliance requirements in Hong Kong and Singapore.

Point95 Global, another crypto hedge fund based in Hong Kong, has also begun preparation since spring in 2018 and is currently perfecting internal processes with plans to raise external capital in 2020.

"We had to build the car and the road at the same time," said Lin Cheung, CEO of Point95 Global, who previously worked at JP Morgan. "Each step was challenging and took a long time."

Both BBShares and Point95 Global also turned to the U.S. to open bank accounts, which usually requires the management team to have U.S. citizens or green card holders and professionals with sufficient investment management work experience. For some teams, this requirement is not easily met.

"The ecosystem in Asia doesn't want to take risks," said one industry expert who did not want to make a critical comment publicly. "From regulators to financial institutions, they are used to being the follower. They just want to wait and copy what has worked in developed markets."

First-mover advantage?

Nevertheless, there are clear signs that concrete developments are finally taking place in Asia.

For the believers in institutional adoption, getting ready before institutions deploy capital to crypto en masse provides a first-mover advantage.

"You can't wait until institutions are putting money in tomorrow. That will be too late," said Point95 Global's Cheung.

It's difficult to predict what will happen in regulated crypto funds in the next three years, or even the next year, said BBShare's Li. "This market moves so quickly. But we are very bullish on crypto's long-term potential and our fund's value proposition.”

Others are thinking about creating intermediate products such as managed accounts since the cost of setting up and operating a licensed crypto hedge fund is very high.

Considering most investors who are deploying capital today are high net-worth individuals and family offices, a managed account can serve as a decent option. CYBEX's Jianbo Wang and Point95 Global are both considering launching such services soon.

Others are not so hasty. Amber's Kullander said that a lot of requests his firm sees still stop at inquiry. "If they are poking around only now, it's likely that they will be very slow."

Such caution can create its own risks.

"There has certainly been more talk than action," said InVault's Xu. "A crypto fund might take two years to prepare all the documentation, licenses, and meet compliance requirements. But in the world of crypto, the market could be upside down in that time frame."

That may be true. But for the first movers, the upside is well worth the risk.

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