Managers taking bigger steps into crypto

Opportunistic hedge fund managers, especially those running relative-value, market-neutral and multistrategy funds, increasingly are investing relatively small percentages of their funds in cryptocurrencies — primarily via bitcoin and ether futures and options — to take advantage of arbitrage plays.

Other managers — including Brevan Howard Asset Management LLP, London, and BKCoin Capital LP, Miami — that are running pure-play digital-coin hedge funds are seeing burgeoning interest from institutional investors, although consultants say the asset class may still be a little too lightly regulated for a full-scale move by retirement plans, endowments and foundations.

"There is a lot of interest in hedge funds that invest in cryptocurrency, including from asset owners, but it's all about education and not much investment at this point," said Sara Rejal, senior director, investments, at Willis Towers Watson PLC, London.

The big opportunity for hedge funds investing in cryptocurrency is that trading in bitcoin is not centrally traded, said Christopher Solarz, a New York-based managing director of alternatives consultant Cliffwater LLC.

"Bitcoin and ethereum don't trade on the New York Stock Exchange but they are traded on 500 exchanges, which means that hedge fund managers, especially quantitative managers, have a lot of exchange-arbitrage opportunities to exploit," Mr. Solarz said.

Long-established hedge fund manager Brevan Howard, which was founded in 2002, is taking advantage of favorable cryptocurrency market conditions to move into dedicated cryptocurrency management.

The hedge fund firm in September launched BH Digital, a dedicated unit that focuses on asset management of a broad range of cryptocurrency and other digital assets.

Brevan Howard committed $250 million to the digital business, said a person knowledgeable about the firm who asked not to be named.

The unit's BH Digital Multi-Strategy Fund launched Jan. 1 with internal capital. The source could not provide the amount of the internal investment.

The digital assets fund expects to receive external capital later this year, including from institutional investors, said the source. The person could not say how much external capital has been pledged to the fund or name the investors. However, BH Digital will name some of the investors when they have invested in the fund, the person said.

Brevan Howard managed $18.5 billion in hedge funds as of Jan. 31.

BKCoin, a comparative newcomer to asset management, was launched in 2018 with the goal of bringing "institutional-grade strategies as well as risk management and compliance to this new asset class," said Kevin Kang, New York-based founding principal and CIO.

"Because a lot of funds in the space back in 2017 and 2018 were mostly venture funds and buy-and-hold passive strategies, we really wanted to bring actively managed market-neutral strategies for institutional investors to give them exposure to this exciting asset class but with much less volatility," Mr. Kang said.

Investors in the firm's early years included family, friends, family offices and hedge funds of funds, he said.

This year, Mr. Kang said the conversation is with institutional investors because the firm beefed up its infrastructure including custody, fund administration, audit and other operational practices that helped asset owners feel more comfortable about investing with BKCoin.

The firm will open the fund to new investors in April, Mr. Kang said.

He said he cannot name the new investors or the amount slated for investment. BKCoin managed $145 million as of Feb. 28.

Systematic macro managers are "just dipping their toes into cryptocurrency now, trying to get a bit of exposure — perhaps half a percent — as they test whether they can scale up the investment as they arbitrage between different cryptocurrencies," said Patrick Ghali, co-founder and managing partner of alternatives consultant Sussex Partners U.K. Ltd., London.

London-based systematic manager Aspect Capital Ltd. monitored cryptocurrencies for some time before making its first move, said Martin Lueck, co-founder and research director, in an email.

"With the introduction of futures on bitcoin and ethereum, we found them sufficiently liquid and diversifying to merit an allocation alongside our other alternative markets," Mr. Lueck said.

He noted, however, that the firm does not trade spot currencies (a continuous process of buying and selling tokens and coins at a spot price for immediate settlement) because "the ecosystem is not quite mature enough for our conservative approach to risk management and institutional investors."

Aspect managed $9.1 billion as of Feb. 28.

In contrast, New York-based hedge fund manager Hudson Bay Capital Management LP does invest in spot bitcoin when it makes sense, said Yoav Roth, managing director and portfolio manager, in an email.

"We look for alpha wherever it exists, including digital assets. For example, in the past, we've been able to uncover attractive arbitrage opportunities involving CME bitcoin futures and spot bitcoin that are in line with our risk parameters," Mr. Roth said.

Hudson Bay managed $15 billion as of March 1.

One of the industry's largest hedge fund managers, Chicago-based Citadel Advisors LLC, which managed $47 billion as of March 31, is "not one of the firms that may be dipping their toes into cryptocurrency," said Zia Ahmed, a company spokesman, in an email.

However, market maker Citadel Securities LLC, will add cryptocurrency trading, said Kenneth C. Griffin, founder and CEO of Citadel, in a March 1 Bloomberg video interview. Mr. Griffin is also founder of Citadel Securities.

"I still have my skepticism, but there are hundreds and millions of people in this world today who disagree with that," Mr. Griffin said, adding "to the extent that we're trying to help institutions and investors solve their portfolio allocation problems, we have to give serious consideration to being a market maker in crypto."

"It's fair to assume that over the months to come, you will see us engage in making markets in cryptocurrency," Mr. Griffin said.

Citadel Securities' move to provide cryptocurrency trading makes perfect sense, said Sussex Partners' Mr. Ghali.

"If you can provide the infrastructure, it's like supplying the shovels and pickaxes to the industry," he said.

Consultants are more supportive of asset owners investing in dedicated cryptocurrency funds and in other hedge fund strategies than they were a few years ago.

That's because cryptocurrency is "an uncorrelated and diversifying asset class," which can help performance in current rough markets, said Cliffwater's Mr. Solarz, but he stressed that "institutional investment isn't there yet. The first investors in crypto hedge funds were high-net-worth individuals and family offices, followed by endowments and foundations."

"Asset owners are interested and some have set up digital asset working groups to assess the potential of cryptocurrency investment," Mr. Solarz said, declining to name asset owners who are doing this.

The $204 billion Teacher Retirement System of Texas, Austin, is among asset owners that are exploring cryptocurrency.

CIO Jase Auby told trustees during a Dec. 7 board meeting that investment staff launched a digital assets working group, noting that "the consensus developing in the investment community is that these types of assets will become investible at some point," according to meeting minutes.

"TRS is continuing to consider the role of digital assets in our portfolio," Mr. Auby said in an email, adding "there is a large overlap with existing portfolios and strategies including venture capital and hedge funds, and we are seeing an increase in opportunity through these established channels."

Mr. Solarz said the ongoing maturation of the cryptocurrency industry is giving investors like Texas Teachers more confidence in investing in the asset class.

"Early on, asset owners were worried about the infrastructure and regulation of crypto assets, but with more digital coin regulations, investment in digital coins is generally accepted in the institutional investment industry," Mr. Solarz said.

Willis Towers Watson's Ms. Rejal on the other hand, said the operational side of cryptocurrency still is in development.

She added that her team has concerns about both the security of cryptocurrency investments and the climate impact of the high energy use for "mining" to acquire digital tokens.