The case against beta
Tribalism is an undeniable part of the crypto markets. Bitcoin maximalists, ETH supporters jumping on the bandwagon of environmentalism or LUNA advocates defending an “unsustainable business model” are only a few examples. Over the years, the performance of such 'tribalisms' has been very rewarding. Chances are high that one would have gained significant returns and in some cases true fortunes if one had always bought one's favorite coin. Today, however, we would like to comment on the advantages of minimizing exposure to the overall market movements and instead focusing on possibilities to isolate one’s edge.
In TradFi the concept of risk premias, advocated by famous Chicago scholars like Cliff Asness of AQR, is a key tool when it comes to market analysis. The main idea is to find a statistically significant source of return drivers like value or momentum and go long the best valued securities in a basket and short the worst securities of that same basket. A wide variety of possibilities to go long or short exists and should only be a starting point for a conversation. The goal is to create a portfolio that is not correlated to the overall basket of securities and only moves because of changes in risk premia.
For example:
Let’s assume over the last 4 weeks ETH, EOS and BCH had very strong momentum based on some metric and the three worst performers based on this metric were BTC, SOL and XRP. By shorting BTC, SOL and XRP and being Long ETH, EOS and BCH you would create a portfolio without any overall market exposure.
Here’s a short primer and many references for further investigation:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3055498
This concept can be applied to most strategies if one's edge has significance, and the portfolio construction method suits the alpha element (Pairs Trading, Relative Value strategies in general etc.).
But why not just take the beta or market exposure and follow the historical path to riches?
Past performance is not indicative of future results but more importantly it is a way to generate returns in phases where the market might be in a prolonged bear market or a boring sideways market. And given the significant opportunities and volatility in the crypto market, returns can be very high and would not give you the feeling of missing out.
Further advantages arise from a portfolio construction angle. Due to the very low or negative correlation of beta neutral strategies to the overall market, diversification aspects should increase the overall performance of the portfolio. No matter if you are a small investor or multi-billion USD hedge fund magnate.
To show diversification effects, we encourage everyone to play around with Winton’s Future Tool (https://tools.winton.com/thefuture/).
For a more detailed discussion and to find out how we think about diversification and beta neutrality, feel free to reach out to us.
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