Institutions seek out non-correlated assets after 2022 losses in stocks and bonds

Pension funds, hedge funds, family offices, banks and other institutions are eager to invest in assets uncorrelated to losing stocks and bonds — and these days they're wading into strategies like cryptocurrency bankruptcy claims and interest rate trades.

After billion-dollar bankruptcies, secondary markets usually spring up to buy and sell claims by customers, vendors and investors. The newest bankruptcy claims stem from Sam Bankman-Fried's former crypto empire FTX Group, which filed for Chapter 11 in November. FTX has since been joined by other crypto bankruptcies including Genesis, BlockFi, Celsius Network and Voyager Digital.

In addition, interest-rate risk funds are attracting money from institutions. In periods of high inflation such as today, the usual negative correlation between bonds and stocks unravels, and both asset classes fall together, "which is exactly what we have seen in 2022," said Nancy Davis, founder, managing partner and CIO of Quadratic Capital Management and portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge ETF, based in Greenwich, Conn.

"Both planks of the usual 60/40 portfolio are down for the year," she said, as the S&P 500 and the 10-year Treasury were both down close to 20% in 2022.

Genesis, a division of Digital Currency Group, now also has customers selling their bankruptcy claims to cut their losses and move on rather than wait for the bankruptcy process to play out.

Institutional buyers are betting that heavily discounted creditor claims on Genesis, FTX and others will pay off. Currently, FTX customers can get 15 cents on the dollar for claims, according to online trading marketplace Xclaim.

Crypto customers have listed claims totaling more than $200 million there, and the total market equals about $30 billion of claims against companies including Genesis, Voyager, Celsius, BlockFi and others, said Xclaim founder and CEO Matthew Sedigh in an interview.

Specialized brokers advertising trading in FTX and other crypto claims include Seaport Global, Jefferies, Citigroup and Xclaim.

The trading of bankruptcy claims "has come fast and furious. These are large cases with millions of users," said Mr. Sedigh. In just the past month, the exchange has traded claims in FTX, Celsius, BlockFi, Voyager Digital and Genesis.

About 300 institutions have registered to buy and sell claims, including hedge funds, banks and family offices, including one institution with a $500 million FTX account balance. Currently FTX bankruptcy claims trade between 12 cents to 15 cents on the dollar.

Pension funds have so far avoided the bankruptcy claims market directly, although their underlying fund investments may be investors.

For example, venture and private equity funds and firms that invested directly in FTX include Institutional Venture Partners XVII, Lightspeed Venture Partners and others. Pension funds that have invested in Institutional Venture Partners include the $60.7 billion Illinois Teachers' Retirement System, Springfield, and the $40.8 billion Texas County & District Retirement System, Austin. Lightspeed Venture Partners funds have raised money from $47.3 billion Illinois Municipal Retirement Fund, Oak Brook; the Texas County & District Retirement System, Austin, the $173.3 billion Texas Teacher Retirement System, Austin, and the $89.7 billion Michigan Retirement Systems, East Lansing.

Two out of three pension funds in Fairfax Va., with $9 billion in assets, are overseen by CIOs Katherine Molnar and Andrew Spellar. The two funds put money in Morgan Creek Blockchain Opportunity fund I, II and III; Blockchain Capital funds V and VI; Polychain Ventures III; and EJF Silvergate Ventures Fund.

The latter fund has "some exposure to blockchain, and a fintech focus with a crossover exposure," said Ms. Molnar, CIO of the Fairfax County Police Officers Retirement System, in a Jan. 18 webinar with the McLean (Va.) Citizens Association.

"We have a smaller amount in other strategies, Parataxis Absolute Return Fund, which we recently redeemed. That traded long- and short-hedged exposure to cryptocurrencies."

Some other Parataxis and Van Eck fund investments are viewed as fixed-income replacements in the pension fund's allocation, she said.

Estimated crypto exposure via private equity fund investments represents about 1% in the city fund and 2.5% in the police pension fund, said Mr. Spellar, CIO of the Fairfax County Employees' Retirement System.

"Bitcoin we own was bought at a very low price," Mr. Spellar said. "What we're talking about here … is a really small portion of our portfolio," he said. The pension funds have no plans to sell at this time, according to the webinar.

Fairfax pension funds are not currently buying cryptocurrency claims. However, "at some point, somebody's going to approach us about distressed investing in the crypto space," said Mr. Spellar. "That might be a very attractive opportunity. We haven't had that discussion yet. That would be more of a credit play. Typically, that's something we look for. We're very forward-leaning,"

Investors also are putting money to work in uncorrelated assets such as Ms. Davis' fund at Quadratic, as "we don't rely on credit spreads," she said. "We take a different type of spread risk — interest rate spread risk. It really is non-correlated because it's completely different."

It's important for institutional investors to "think about your liquidity sleeve, especially since they own so much in private markets. Using ETFs like ours is a win for institutions, as they can move large size without making an impact on the market; and they get full transparency," she said.

Her fund, the $1 billion Quadratic Interest Rate Volatility And Inflation Hedge ETF, has attracted "a lot of interest on the insurance company side, as well as endowments and foundations. They're embracing ETFs more as a technology to access the bond markets. Our strategy is very much on their minds too as a hedge to their private equity holdings," Ms. Davis said.