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The active management toolbox: Essential strategies for digital assets | Image by Unsplash
Active management is key to maximizing returns in the dynamic world of digital assets. In our previous articles, we explored the role of active management in leveraging market volatility and the unique market microstructure of digital assets. Now, we turn our attention to the core techniques that empower active managers to achieve superior risk-adjusted returns.
Active managers utilize a diverse array of investment management techniques tailored to the unique characteristics of digital assets. In particular,
- Trend-Following: Systematically identifying and investing in sustained price movements, both upward and downward, to generate returns.
- Derivatives Strategies: Employing options and futures contracts to hedge against price volatility, accumulate coins or express views on future price movements.
- Risk Management: Deploying sophisticated risk management practices to safeguard investments such as position sizing, stop loss orders, and hedging.
Let’s explore each of these techniques and how they collectively contribute to a robust and successful investment strategy in the digital asset space. To learn more about the role of active management in digital assets, download the whitepaper "The Role of Active Management: The Next Step in Investing in Digital Assets”
Trend-Following: Capitalizing on market momentum
What it is:
Trend-following strategies are investment strategies that identify and capitalize on sustained price movements, profiting from both upward and downward trends.
Key benefits:
This strategy optimizes returns while mitigating risk by dynamically adjusting to market conditions, delivering uncorrelated performance that stabilizes portfolio volatility.
Impact on portfolio construction:
Adding a trend-following on cryptocurrencies strategy to a traditional 60/40 portfolio boosts diversification and provides dynamic flexibility, improving overall risk-adjusted returns.
Trend-following strategies thrive on the principle of momentum—once prices begin moving in a particular direction, they often continue in that trajectory for some time. Active managers leverage this by systematically identifying and riding these sustained price movements, whether the market is trending upward or downward.
This approach relies on careful analysis of momentum indicators, such as the 30-day momentum signal often used with assets like Bitcoin. For example, if Bitcoin’s price has shown a steady increase over the past 30 days, an active manager might initiate a long position, anticipating that the upward trend will persist. Conversely, if the price has been on a downward trajectory, the manager might take a short position, aiming to profit as the decline continues.
Annualized information ratio (IR)**
*Hypothetical simulated performance results have certain inherent limitations. There is no guarantee that the market conditions during the past period will be present in the future. **Information ratio: Defined differently from standard finance definitions to mean just the (Average annual return x SQRT (12) / (Standard deviation of monthly returns) and not taking into account returns relative to a benchmark. IR in this context just indicates how much return an investment generates relative to the amount of risk taken. A higher information ratio implies better performance relative to risk.
Enhancing a 60/40 portfolio with Trend-Following strategies
Integrating trend-following strategies into a traditional 60/40 portfolio—60% equities and 40% bonds—can significantly boost performance by enhancing returns and reducing risk. While the 60/40 portfolio balances growth and stability, adding trend-following strategies, especially in digital assets, optimizes this mix.
- Better risk-adjusted returns: Trend-following strategies capture sustained price movements, independent of traditional asset classes, enhancing portfolio performance, particularly when equities or bonds underperform.
- Risk reduction: These strategies adapt to market conditions by shifting between long and short positions, providing protection against downturns and reducing overall volatility.
- Diversification: Trend-following introduces uncorrelated returns, offering valuable diversification that smooths portfolio performance, especially during market stress.
- Dynamic management: The inclusion of trend-following allows for more tactical flexibility, with active managers adjusting exposure based on market trends, improving risk-adjusted returns over time.
Derivatives strategies: Enhancing returns with options and futures
What it is:
Derivative strategies involve using financial instruments whose value is tied to an underlying asset, like Bitcoin. One common approach is volatility selling, where traders capitalize on market fluctuations by writing options. Specifically, selling put options allows investors to generate income from the option premiums, benefiting from periods of heightened volatility. This strategy also positions them to acquire assets like Bitcoin at a discount if prices dip below the option's strike price, effectively turning market downturns into buying opportunities.
Impact on portfolio construction:
Volatility-selling strategies balance income generation with risk management, protecting holdings during market volatility while still offering opportunities for growth.
Actively managed derivatives strategies, particularly those involving options, offer a sophisticated approach to generating income while managing risk. A prime example is the use of put options in volatility-selling strategies. Here, active managers systematically write put options, which provide the buyer the right to sell Bitcoin for example at a predetermined price. This strategy is particularly appealing to investors who already hold assets and are looking to generate additional yield on their existing holdings.
BTC accumulation (max notional exposure of 65% of AUM)
Volatility-selling strategies
By selling put options, managers collect premiums, providing a steady income stream. If Bitcoin’s price remains stable or rises, the options expire worthless, and the manager retains the premium, effectively enhancing returns without requiring any additional investment in Bitcoin. On the other hand, if the price of Bitcoin falls, the put options may be exercised, allowing the manager to acquire more Bitcoin at a lower price. This not only preserves capital but also potentially adds to the investor’s Bitcoin holdings at a discount, creating opportunities for future gains.
Balancing returns and risk
This strategy is particularly effective in managing risk during periods of market volatility. By prioritizing capital preservation and systematically generating yield, volatility-selling strategies offer a balanced approach that protects digital assets holdings from significant downside while still providing opportunities for income. It’s a way to make market volatility work in favor of the investor, turning potential risks into strategic advantages.
Maximum drawdown of volatility-selling strategies
Risk management: Ensuring investment security with strategic precision
What it is:
Risk management involves applying market expertise, strategic thinking, and continuous monitoring to safeguard investments, particularly in the volatile digital assets space.
Key benefits:
Effective risk management protects against rapidly downside risks through strategies like hedging and liquidity management, while real-time data monitoring allows for swift adjustments to market changes.
Impact on portfolio construction:
By understanding risks, active managers ensure portfolios are not taken unintended and remain secure, resilient, and well-positioned to capitalize on opportunities in dynamic market conditions.
Effective risk management is the cornerstone of successful investing, particularly in the volatile and rapidly evolving world of digital assets. Active managers apply a combination of market expertise, strategic thinking, proactive decision-making, and continuous monitoring to safeguard investments and optimize returns. Here’s how they do it:
In-depth understanding of market dynamics
Active managers have a deep understanding of the dynamic and rapidly evolving crypto markets, allowing them to anticipate and mitigate any unintended risks effectively. They are well-versed in the unique risk profiles of various cryptocurrencies, enabling informed risk management decisions.
Risk management strategies
To protect against the inherent risks of digital assets, active managers employ a variety of strategies:
- Hedging: By using derivatives like options and futures, managers can hedge against potential adverse moves. For instance, they might use options to lock in prices, thereby protecting the portfolio from extreme market movements. This strategy not only shields the portfolio from losses but also provides a safety net during periods of heightened volatility.
- Liquidity management: Ensuring sufficient liquidity is another critical aspect of risk management. Active managers strategically maintain adequate liquidity to meet potential redemption requests or quickly capitalize on sudden market opportunities without being forced to sell assets at a loss. This approach ensures that the portfolio remains flexible and responsive, even in turbulent market conditions. Effective liquidity management protects the portfolio from liquidity crises and allows for tactical allocation changes as market conditions evolve.
- Prudent leverage: Active managers strategically employ prudent leverage to amplify returns and capitalize on specific market opportunities without disproportionately increasing risk. By carefully controlling leverage, they invest in high-conviction investment ideas at opportune moments. Strict risk management ensures borrowed capital enhances performance while keeping risk within acceptable boundaries. This approach makes portfolios more dynamic and responsive, leading to superior returns.
Continuous monitoring and real-time data
Risk management in the digital asset space requires more than just a set of static strategies—it demands continuous monitoring and real-time responsiveness. Active managers leverage advanced data analytics and proprietary systems to monitor market conditions and portfolio performance in real-time. This real-time data allows them to make swift adjustments to the portfolio, responding proactively to emerging risks. Additionally, they track key performance metrics and risk indicators such as volatility and drawdowns. By keeping a close eye on these metrics, managers maintain a comprehensive understanding of the portfolio’s risk profile at all times, ensuring that it remains aligned with the overall investment strategy and risk tolerance.
Active management plays a crucial role in navigating the complexities and opportunities of the digital asset market. By employing investment management techniques such as trend-following strategies, derivatives, and dynamic risk management, active managers can significantly enhance portfolio performance while effectively mitigating risks. These tailored approaches ensure that your investments are not only protected but also positioned to capitalize on market opportunities, regardless of volatility.
For investors seeking to optimize their digital asset portfolios, active management offers a pathway to superior risk-adjusted returns, enhanced diversification, and strategic flexibility. Whether you're looking to generate yield, protect your assets, or dynamically adjust your portfolio to market conditions, the expertise of active managers can be a game-changer. Connect with us to learn how our active management solutions can help you achieve your financial goals in the dynamic world of digital assets.
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