Oct. 16, 2023: As 'crypto winter' thaws, family offices take mixed approach to sector
Is it just me, or does cryptocurrency feel like it’s at an inflection point? Marcus Baram interviewed several families and thought leaders, and the family office sentiment around crypto is mixed, to say the least. But those who are still willing to take the risk and ride the wave hope there’s a big payoff on the other end. With new regulations on the horizon, those who are bullish are excited for what’s to come.
We’ve been hearing rumblings for a while, but hedge funds now really seem to be out of favor for the high-net-worth investor. Our sister publication Pensions & Investments shares a piece written by Michael Rosen, CIO of Angeles Wealth Management, in which he argues a simple point: Hedge fund fees are simply too high. Poor liquidity and a lack of transparency don’t help, either. We’ll be keeping a close eye on hedge funds as we close this year out and see what’s in store for 2024.
As always, we appreciate any comments, ideas and insights that would make this newsletter more useful. I look forward to growing this family office community with your help. Please email me at [email protected].
HANDPICKED: As 'crypto winter' thaws, family offices take mixed approach to sector
By MARCUS BARAM
In the wake of the crypto winter — a "Game of Thrones" reference to a period in 2022 marked by a steep decline in cryptocurrency prices and the failure of several stablecoins — family offices are taking a mixed approach to the sector. While some are cautiously dipping their toes back in, others are jumping in head-first — and some avoiding the sector altogether.
Though it tends to be a volatile sector amid uncertainty over future regulation, things are definitely looking up. Bitcoin is far off its all-time high of $68,000 in 2021, but it’s trading up 68% since the start of the year. A Standard Chartered analyst recently predicted that ethereum could climb 400% and reach $8,000 by the end of 2026.
The percentage of family offices invested in cryptocurrencies rose from 16% in 2021 to 26% in 2023, according to a Goldman Sachs Family Office Investment Insights report last month. Yet the share of family offices that have not invested in crypto or are not interested in investing in the sector jumped to 62% from 39% during that period, and the share of offices that said they were considering future crypto investments plummeted from 45% to 12%.
“Many of our wealthiest clients [more than $100 million in assets] are willing to allocate a small portion of their portfolio, such as ½%, to very risky investments [like crypto], with the understanding that there is a good chance that it goes to $0,” said Jon Ekoniak, a partner at Bordeaux Wealth Advisers, a multi-family office in Menlo Park, California.
"But if it is successful, it could generate a very generous return."
Others are experiencing fear-of-missing-out as the sector rebounds. “A lot of the family offices I work with didn’t get in a few years ago,” said Ben Wiener, the founder of Benaiah Capital in Sioux Falls, South Dakota, an investment firm focused on digital assets. “They got talked out of buying bitcoin at $60,000, and they’ve been wanting to buy it.”
Recently, Wiener gave a presentation to 57 private family trusts in South Dakota and was approached afterward by a woman whose family has a $1.5 billion portfolio. “She said: ‘Nice job. I think that you’re onto something here. People thought I was crazy when I bought gold at $200 in the '70s.’ ”
The trust ended up investing $20 million with his firm, Wiener said.
That’s in contrast to the trend at family offices, where “next-gen family members are definitely the ones who are some of the loudest voices in the investment community and don’t have to defend their positions [on crypto] as loudly as they once did,” said Michael Sonnenshein, CEO of Grayscale Investments, the world’s largest digital currency asset manager.
In his experience with family offices and retail customers, Sonnenshein said that “there is now a widely held belief that crypto as an asset class is here to stay” and that investors have been buoyed by the relative stability of prices and the lack of volatility, prompting greater diversification beyond just bitcoin and ethereum.
Others have been avoiding the sector. “We have not been getting back into crypto, and I haven’t heard much from family offices that are,” said Maximilian Winter, a fourth-generation entrepreneur who invests from the Winter Family Office, which has offices in Switzerland and the U.S. Winter's peers are letting the space “cool off for a while, as they had already spent a disproportionate amount of time on it,” Winter said. He expects the sector “will bounce back during the next upswing.”
Much of that depends on the regulatory landscape, which remains unclear right now, though the Biden administration is taking a tougher stance. Securities and Exchange Commission Chairman Gary Gensler has said that he will aggressively pursue enforcement actions and that Congress should consider a law to regulate crypto exchanges.
“It is likely that family office interest in crypto will increase with respect to any decisions made by the SEC or approves spot bitcoin [an exchange-traded fund],” said Shane Rodgers, chairman and CEO of PDX Advisers, a New York-based investment unit of Singapore-based PDX Global.
And Grayscale's Sonnenshein is optimistic “that we could see some increased clarity from our legislators that the market deeply deserves and has been waiting for,” pointing to bipartisan support for several crypto bills in Congress.
Family offices see that “regulation still has a little way to go,” said Wiener. “But it’s on its way, and if you wait to get into the sector, it’s too late.”
Commentary: Hedge funds do not offer value to pension funds and other investors
By MICHAEL A. ROSEN
When I began investing in hedge funds more than 30 years ago, the value proposition was absolute return: modest but positive returns regardless of market conditions. One percent per month was the oft-cited promise. It turns out the only hedge fund that was able to deliver 1% per month was Bernie Madoff, and that was only because it was a fraud.
The internet bubble of 2000 punctured the myth of absolute returns in hedge funds. Then the promise turned to equity returns with bond volatility. That promise was shattered in the detritus of the global financial crisis of 2008. Then the value proposition changed to strong risk-adjusted returns. That, too, has been unfilled.
In the 10-year period through June 30, 2023, the S&P 500 index returned 12.7% per year, and the Bloomberg U.S. Corporate High Yield index returned 4.4%. The HFRI Equity Hedge index returned 5.7%, the HFRI Fund Weighted index returned 4.7%, and the fund-of-funds index returned 3.4%.
There is no combination of stocks and high-yield bonds that did not outperform hedge funds. In the past decade, equities outperformed hedge funds in every calendar year but 2022 and are well ahead again this year.
It's been a long time since hedge funds provided absolute returns; kept pace with equities with lower volatility; and offered attractive, risk-adjusted returns, since investors could create superior risk-adjusted performance through any combination of low-cost ETFs of stocks and bonds.
Hedge funds have simply not delivered on any of their promises for the past 30 years. The problem is not merely poor execution; it is structural — that is, it is unlikely hedge funds can, much less will, deliver an attractive value proposition. The reason is fees.
FEES ARE TOO HIGH A HURDLE
Fees are simply too high a hurdle for hedge fund managers to offer an attractive return to investors. Simple math will prove the point.
Let's assume a hedge fund fee of 1.3% of assets plus 16% of any positive return. This is close to the average hedge fund fee. If the underlying benchmark — stocks, bonds or any combination therein — returns 5%, then the hedge fund will have to earn 2.1% above the benchmark to provide the investor with a comparable net return of 5%. If the underlying benchmark return is 10%, the hedge fund will need to add 2.9% above that to provide the investor with a comparable return.
There simply isn't enough alpha (excess return) to justify these fees. And these hurdles, 2.1% and 2.9% in the examples above, are merely the required break-even alphas that hedge fund managers must deliver. To justify these fees, managers will need to earn well in excess of these hurdles. There is little (well, actually, no) evidence that hedge fund managers can generate these alphas.
Fees are not the only hurdle with hedge funds. Poor liquidity and often a lack of transparency add to the problem.
There is no justification for any illiquidity in strategies (primarily equity long-short) investing in listed securities. Yet, most such funds limit quarterly redemptions and retain the unilateral right to suspend even that. Even the less liquid areas of the fixed-income markets can be liquidated over the 90 days of notification hedge funds typically require.
Yet many hedge funds not only limit quarterly redemptions but often require more than a year for a full redemption. In public securities! To accept these unjustifiable liquidity provisions, investors would need to be adequately compensated. As we've shown, they have not been.
Transparency is another unjustified imposition by some hedge funds. At Angeles, we require some degree of position transparency. We have signed NDAs, we have agreed to examine the books on-site, but we insist on being able to see all the positions in the portfolio. We consider this to be a fiduciary responsibility, and we are fiduciaries.
This transparency requirement would have helped investors avoid a number of headline disasters. Amaranth Advisors was a $9 billion hedge fund that had posted very strong returns and gathered money from the largest banks and pension funds in the country. They refused to show potential investors their books on-site, even under an NDA. They reasoned that they had many prominent investors willing to invest without this transparency, so there was no reason to open their books.
You know what happened: In 2006, the firm blew up, as it had the majority of its assets in a single bet on natural gas futures that went against them.
Requiring transparency would have helped investors avoid the frauds at Madoff (discovered in 2008) and at Westridge (uncovered in 2009).
Yet institutional investors, and their consultants, continue to invest in funds without receiving full transparency.
With about $4 trillion invested in hedge funds and total fees at about 2.5%, investors are paying hedge fund managers an estimated $100 billion per year in fees. In return, investors have received poor performance, limited access to their money, and periodic leverage blow-up and outright fraud. The case for investing in hedge funds does not withstand scrutiny, and investors are well-advised to allocate elsewhere.
CFTC head calls for broader crypto regulatory authority: "Now with technology changing, now with the growing capacity for retail investors and actually investors across the board to have access to markets, we have to change," said CFTC Chairman Rostin Behnam.
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Help us with a story: We’re working on a story about setting up a family office in Asia. If you have any comments on the topic, reach out to [email protected].