September 27, 2017 / 8:35 PM / 2 years ago

Breakingviews - Crypto-currencies can't salvage hedge-fund junkies

A Bitcoin (virtual currency) coin is seen in an illustration picture taken at La Maison du Bitcoin in Paris, France, June 23, 2017. REUTERS/Benoit Tessier/Illustration - RTS18BSL

DALLAS (Reuters Breakingviews) - Hedge-fund star Mike Novogratz thinks he has crypto-currencies figured out. The one-time manager of Fortress Investment Group’s flagship macro fund is pinning his comeback hopes on digital coins. Their volatility is alluring when tranquil markets are depressing industry returns. But that can be a trap, as the investor well knows.

The volatility of stocks in the S&P 500 Index, as measured by the VIX, last year averaged about half its level of 2008 and 2009, and is on track to set a record low this month. The result is painful for hedge funds, which rely on sharp market moves to make their bets pay off. Hedge Fund Research’s Fund Weighted Composite Index trailed the S&P 500 by five percentage points in the first eight months of this year.

Digital money seems like the perfect antidote. Bitcoin has risen fourfold since the start of the year, notwithstanding a 34 percent plunge in early September. Novogratz, who began dabbling in the digital realm after crashing out of Fortress two years ago, claims to have made enough money to buy a Gulfstream jet. Now he’s aiming to launch a $500 million fund that will invest in the likes of bitcoin, initial coin offerings and related companies, according to Bloomberg.

There are problems with his strategy, though. For starters, there’s no straightforward way to short bitcoin, making it hard for the fund to hedge its holdings. Novogratz says the market is a massive bubble, meaning he must be counting on being a better market-timer than others. That smacks of hubris considering his track record. In 2015, Fortress’s macro fund was shorting the Swiss franc only to see the currency rocket when the central bank suddenly abandoned its peg to the euro. The resulting losses helped lead to the closure of his fund and his retirement from Fortress.

Crypto-currencies don’t depend upon central banks, which is part of their appeal to fans, but that doesn’t lessen their volatility. Exchanges have been hacked, causing big losses, and regulators from Beijing to Washington are starting to clamp down. Bitcoin enjoys a perception of scarcity, as only 21 million can ever be mined, but the potential for rivals is unlimited. A rash of new digital coin offerings has raised more than $1.5 billion so far this year.

In any bubble, there’s always a sucker. Potential investors should be asking whether that’s likely to be Novogratz, or themselves.


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