Half of hedge funds are considering crypto investments: Should investors be concerned?

Anyone active on social media may sometimes feel like they’re seriously missing a trick if they aren’t buying and selling cryptocurrency. Just type ‘bitcoin’ into Twitter and you’ll find charts, predictions and lots of memes about life as a crypto trader. However, these individual users aren’t the only ones trying to profit out of crypto — plenty of hedge funds are getting in on the action too.

A May 2021 report by the Alternative Investment Management Association (AIMA) revealed that 47% of traditional hedge funds are investing or considering investing in cryptocurrencies. 86% of those surveyed also intend to inject more capital into the asset class by the end of the year, while the report also found that the total assets under management for crypto-based hedge funds had jumped from $2 billion in 2019 to almost $3.8 billion in 2020.

Cryptocurrency is dominating discourse in a big way right now, and there are obviously opportunities to profit immensely — we’ve all heard of people who have made thousands or even millions of dollars out of crypto investments. However, as a new and notoriously volatile asset, should investors be concerned about what this could mean for their money?

What are the risks of investing in crypto?

The 53% of hedge funds steering clear of cryptocurrencies have cited reasons including regulatory uncertainty, lack of infrastructure, and client/reputational risk. None of these are unfounded concerns. There is still plenty that’s unknown about cryptocurrency, it’s very difficult to regulate, and there’s significant opposition to it from high-profile names in the industry — including the Bank of England governor Andrew Bailey.

These aren’t the only issues with crypto investing either. Trade Nation also draws attention to crypto trading risks, such as huge losses due to extreme volatility, the rise of crypto scams, and the ‘fear of missing out’ on such a complicated asset. “Lots of people hear about the latest crypto craze turning ordinary people into millionaires and even if they know nothing about it, they’re terrified of passing on a chance to make this their story too,” they explain. “It really isn’t that simple and getting involved is far more risky than [they] probably realise.”

Ultimately, cryptocurrency is still an incredibly new asset and it may not be fully understood for some time. Therefore, many people consider crypto trading as a gamble rather than a well-informed investment. While some investors may be happy to allow their hedge funds to pursue this, others may not feel comfortable with the risk. After all, Bitcoin recently fell below the $30K threshold and other cryptos like Ethereum and Cardano dipped too. Although Bitcoin has since bounced back above the $30k mark, some experts believe this is just the start of further declines. For example, Patrick Heusser, head of trading at Crypto Finance AG, told Coindesk that he is “expecting a strong dip towards $22K”.

So why are hedge funds shifting towards crypto?

Henri Arslanian, crypto leader at PWC (who conducted the research in partnership with AIMA and Elwood Asset Management) thinks there is a clear demand for crypto hedge funds and believes inflow into them will continue to increase “as more and more institutional investors decide to allocate to this fast-growing space”.

The fact is that interest in cryptocurrency is increasing rapidly despite the risk warnings. FCA research has found that 2.3 million Brits now hold crypto — up more than a fifth compared to a year ago — and concluded that cryptocurrencies “appear to have become more normalised”, with more people considering them to be legitimate assets rather than a gamble. However, while cryptocurrency has become more popular, “the overall level of understanding has fallen”.

Therefore, as a desire to invest in crypto seems almost inevitable, hedge funds may be more inclined to engage with it. The alternative is allowing customers to tackle this incredibly complex and unfamiliar asset alone. As Arslanian comments: “For many institutional investors, an allocation to a crypto hedge fund is the natural first step of their crypto journey as it allows them to observe and learn about the asset class via a vehicle and structure they are familiar and comfortable with.”

It’s also important to note that hedge funds will not invest all clients into cryptocurrency. For example, as reported by the Financial Times, Morgan Stanley and Oliver Wyman consultancy have said: “For the moment, crypto investments remain limited to clients that have a high risk tolerance and, even then, investments are typically a low proportion of investable assets.” While cryptocurrency investing is undoubtedly becoming more mainstream, it is definitely not the norm just yet.