Cryptocurrency Hedge Fund
Fund Organisational Structure
Structurally, hedge funds resemble traditional unit trusts. For instance, like unit trusts, they pool investors’ funds and invest them in equities, bonds, options, and other securities. Like mutual funds, they are managed by invited specialists. This is where the similarities end. The range of investment strategies and positions available to hedge funds is vast and often very complex.
A typical hedge fund has a two-tier structure. The most common model is the general/limited partnership. In this model, the general partner is responsible for the activities of the fund, while the limited partners contribute funds and are liable for the fund’s obligations up to the amount of their contributions. As a rule, such a structure implies the presence of 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. The size and structure of fees is one of the main reasons why talented financiers try their hand at this industry. The rewards are higher, and there are some additional, very attractive opportunities that mutual funds cannot even contemplate.
The management fee covers the same services as in traditional funds. The only difference is in the amount: hedge funds typically charge 2% of assets under management (in some cases even more – if the financier has a good track record and is in high demand). This fee alone makes hedge fund management quite a lucrative occupation, but the next one can make a good manager rich.
Most hedge funds pay an incentive fee to the manager of 10-20% of profits (for some this figure is as high as 50%). The idea is to reward a talented financier for good performance. For example, if a hedge fund earns 20% in a year after management fees, the manager will receive a 4% incentive fee. Investors’ returns will be 16%. In many cases, returns remain quite attractive despite the high manager compensation.
However, with the development of the industry and the influx of mediocre professionals, investors are increasingly disappointed with the performance of many funds. One important caveat: the manager only receives an incentive fee on the amount that exceeds 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 a baseline rate of return in order to earn an incentive fee. Sometimes, this is the yield on US Treasury bonds.
Many hedge funds adhere to the classic “2+20” fee structure – the manager receives 2% of net asset value and 20% of profits, although, as mentioned, this structure may vary depending on the organisation. As you might have guessed, we were talking about classic hedge funds. Now let’s talk about the specifics of a hedge fund focused on investing in cryptocurrencies.
Cryptocurrency Hedge Fund
While the structure of a classic fund and a cryptocurrency fund is not much different (although, of course, it is different, but more on that later), the fee structure of the fund to be implemented 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, we offer the lowest management fee in the industry. It will be 15% of the profit for investors who have invested from $50,000 to $300,000 and 10% for investors who have invested $300,000 and more.
As for the fixed management fee, formally we will not charge it. But this is only formally. The motto of the fund is: “We earn only when our client earns.” But, in fact, the fixed fee, of course, will be, more about this in the investment policy of the fund.
For reference: in 2008, more than 90% of US hedge funds reported losses for the year. Many simply went bankrupt. Fund managers boasted not about who made the most money, but who lost the least. But that’s no reason for them to give up their fees for managing clients’ money. They still got their fees, even though their clients suffered direct losses. That’s the whole point of funds. Clients can make money, they can lose money, and the manager (the management company – us) always takes its fee.
Time Structure
Hedge funds do not have the same liquidity as mutual funds. Some accept and disburse funds monthly, others quarterly. The structure of contributions and withdrawals must be consistent with the manager’s strategy. The more liquid the investments, the more frequent the contributions and withdrawals should be. In addition, each fund requires 15-180 days’ notice of planned withdrawals (the interval is also determined by the fund’s strategy). This requirement allows the manager to effectively allocate capital to meet cash needs. Considering that a cryptocurrency hedge fund has very high liquidity, it is proposed to make the following (unique for this industry) time intervals:
• Monthly for investors with investments of $300,000 or more
• Quarterly for investors with investments from $50,000 to $300,000
• Individual terms for investors with investments 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 no later than 3 business days from the date of withdrawal / replenishment of the account in the fund. As you might guess, such a flexible time policy is a consequence of the “youth” of the fund and the need to quickly attract as many new clients as possible. In the future, the time policy may be revised.
Early Redemption
Early redemption is also possible, but initially provides for penalties for the client. Given the initially flexible time policy, it is proposed to introduce quite strict penalties for early withdrawal of funds, amounting to at least 10% of the investment amount for all clients, except for 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, on which the success or failure of all the fund’s work will ultimately depend. On the one hand, in order to obtain the maximum profit, the fund must show the maximum income. The profitability of the fund’s investments will determine the profit of the fund itself. 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 for clients at the very beginning of the fund’s activity, which will completely undermine the confidence of investors at the very beginning of its development. Based on this, the following, rather conservative policy of investing clients’ funds is proposed:
• About 80% of investors’ funds to invest 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 case of unsuccessful play on the rates and a possible sharp drop in the price of cryptocurrencies purchased by the fund, investors will still receive some, albeit small, income from investments in mining. But it’s not all bad for the fund.
Yes, this structure does not imply huge revenues at the start. But, the probability of failure of the fund becomes minimal. The lost income can be compensated. A hedge fund, as a large operator buying mining, can secure an additional fixed income hidden from investors. It’s 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. Typically, those assets that generate some guaranteed return 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 originally included in the direct costs of investors.Artem Arzamasin
Moscow, 2017