Cryptocurrency Hedge Fund
Fund Organisational Structure
Structurally, hedge funds are similar to traditional unit trusts. For instance, like unit trusts, they pool investors’ money and invest it in equities, bonds, options and other securities. Like mutual funds, they are managed by invited professionals. This, perhaps, is where the similarities end. The range of investment strategies available to and positions taken by hedge funds is very broad and often highly complex.
A typical hedge fund has a two-tiered organisational structure. The most common model is the general/limited partnership. In this model, the general partner is responsible for the fund’s activities, while the limited partners contribute capital and are liable for the fund’s obligations up to the amount of their contributions. As a rule, this structure involves at least one company and one limited liability partnership (LLP), although there may be several.
Hedge Fund Fee Structure
Hedge funds differ radically from mutual funds in terms of fees. Their size and structure are one of the main reasons why talented financiers try their hand at this industry. The remuneration here is higher, in addition, there are some additional very attractive opportunities that mutual funds cannot even think of.
The management fee covers the same services as in conventional funds. The only difference is in the amount: usually hedge funds charge 2% of assets under management (in some cases even more – if the financier has proven himself well and is in high demand). This fee alone makes hedge fund management a fairly profitable occupation, but the next one can enrich a good manager.
Most hedge funds pay an incentive fee to the manager in the amount of 10-20% of the profit (for some, this figure is as high as 50%). The idea is to reward a talented financier for good results. For example, if a hedge fund earned 20% per year, including a management fee, the manager will receive a reward of 4%. Investor profit will be 16%. In many cases, the return remains quite attractive despite the high remuneration of the manager.
However, with the development of the industry and the influx of mediocre specialists, investors are increasingly disappointed with the performance of many funds. One caveat is important here: the manager receives remuneration only from the amount exceeding the previous peak in capital. In other words, if the fund loses 5%, the manager will not receive an incentive fee until the losses are recovered. In addition, in some hedge funds, the manager is required to exceed the base rate of return in order to earn remuneration. Sometimes, it is the yield on US Treasury bonds.
Many hedge funds adhere to the classic “2+20” fee structure – the manager receives 2% of the value of net assets and 20% of the profit, although, as already mentioned, this scheme may vary depending on the organization. As it was not difficult to guess, before that it was about classic hedge funds. Next, we will talk about the specifics of a hedge fund focused on investing in cryptocurrencies.
Cryptocurrency Hedge Fund
If the structure of a classic and a cryptocurrency fund is, in essence, not much different (although, of course, it is different, but more on that later), the fee structure of the proposed fund will be slightly modified. The performance fee in our fund will depend on the size of the investment. Considering that the fund is actually a startup, the minimum management fee in this industry is offered. This will be 15% of the profits for investors who have invested from $50,000 to $300,000 and 10% for investors who have invested $300,000 or more in the fund.
As for the fixed management fee, formally we will not charge it. But this is only formally. The motto of the fund: “We earn only when our client earns.” But, in fact, there will be a fixed fee, of course, more on this in the fund’s investment policy.
For reference: in 2008, more than 90% of American hedge funds showed losses at the end of the year. Many simply went bankrupt. Fund managers boasted not about who earned the most, but who lost the least. But this is not a reason for them to refuse remuneration for managing client funds. They still received their commission, even despite the direct losses of their clients. This is the whole point of funds. Clients can earn, they can lose money, and the manager (management company – we) always takes their commission.
Time Structure
Hedge funds do not have the same liquidity as unit trusts. Some accept and disburse funds monthly, others quarterly. The structure of investments and withdrawals must be aligned with the manager’s strategy. The more liquid the investments, the more frequent the investments and withdrawals should be. In addition, each fund requires 15-180 days’ prior notice of any planned withdrawal (the interval is also determined by the fund’s strategy). This requirement allows the manager to effectively allocate capital to cover cash needs. Given that a cryptocurrency hedge fund has very high liquidity, it is proposed to make the following (unique to this industry) time intervals:
• Monthly for investors with an investment amount of $300,000 or more
• Quarterly for investors with an investment amount between $50,000 and $300,000
• Individual terms for investors with an investment amount of $1,000,000 or more (in fact, you can enter at any time, the withdrawal period is also negotiated individually).
Prior notice of cash flow is no later than 3 business days from the date of withdrawal/deposit to/from the fund account. As you might guess, such a flexible time policy is a consequence of the “youth” of the fund and the need to attract as many new clients as possible as soon as possible. In the future, the time policy may be revised.
Early Withdrawal
Early withdrawal is also possible, but initially provides for penalties for the client. Given the initially most flexible time policy, it is proposed to introduce rather strict penalties for early withdrawal of funds, amounting to at least 10% of the investment amount for all clients, with the exception of investors who have invested more than $1,000,000 in the fund. As mentioned earlier, for this category of investors there will be individual conditions agreed separately with each client.
Investment Policy
Perhaps the most difficult and controversial aspect of the fund’s activities, which will ultimately determine the success or failure of all the work of the fund. On the one hand, in order to obtain the maximum profit, the fund needs to show the maximum return. The profit of the fund itself will depend on the return on the fund’s investments. But, as everyone knows, the higher the expected return, the higher the risk.
And what is the worst thing for a new fund? To show losses to clients at the very beginning of the fund’s operation, which will completely undermine investor confidence at the very initial stage of development. Based on this, the following, rather conservative policy of investing clients’ funds is proposed:
• To invest about 80% of investors’ funds in cryptocurrency mining, which will provide a relatively small, but stable income.
• The remaining 20% can be used for active speculation on the purchase and sale of various cryptocurrencies.
This investment structure is due to the fact that even in the event of an unsuccessful game on exchange rates and a possible sharp drop in the price of cryptocurrencies purchased by the fund, investors will still receive some, albeit small, income from investing in mining. But, not everything is so bad for the fund.
Yes, this structure does not imply huge income at the start. But, the probability of failure of the fund becomes minimal. Lost income can be compensated. A hedge fund, as a large operator buying mining, can provide itself with an additional fixed income hidden from investors. Everything is very simple: out of $100 received from mining, $95 goes to the fund’s income, and the remaining $5 goes to the fund’s management company as a kind of separate commission. This could be any service, such as an affiliate reward for attracting clients. This is the uniqueness of a cryptocurrency hedge fund. Usually, those assets that bring some guaranteed income have a yield of 3-5% per annum. Of course, we are talking about income in foreign currency. As a rule, these are bonds or other instruments with a fixed income. But, the income from mining is much higher than the income from investing in bonds. Plus there is the possibility of receiving an additional fixed commission, not initially included in the direct costs of investors.
Artem Arzamasin
Moscow, 2017
