A General Strategy on How to Select a Crypto Fund, Part 2

Assessing the return/risk profile of a directional trading crypto fundAssessing the expected return of a directional fundInvestors in a directional fund should first have a clear understanding of the dynamic of the fund's overall strategy in order to realize where the performance will come from and over what period before assessing whether the risk taken to achieve such results is worth it.

Understanding the strategy timeframeUnderstanding the timeframe through which a fund strategy works - i.e., intraday and/or on a several-day basis - and the broad expectations of the strategy in terms of capturing market movements - e.g., captures 80% of an upward move, 30% of a downward move on average - are necessary to make a meaningful comparison against a potential benchmark.

Assessing the risk profile of a directional fundIn order to assess the risk profile of a directional fund, an advanced - i.e., nonlinear - hedge fund analysis framework is useful, but metrics of a crypto fund cannot be compared with the metrics of a traditional hedge fund - e.g., volatility, Sharpe ratio, etc.

Fund A:.Fund B:.Fund C:.The volatility of Fund B is 5.3%, whereas the volatility of Fund A is 23.1%. Thus, if considering the overall volatility as a risk measure, then Fund B is much less risky than Fund A, whereas Fund C lies between.

Looking at the positive and negative volatility of each fund leads to a very different conclusion from just looking at their overall volatility: Fund C having the highest negative volatility and the lowest positive volatility is actually the riskiest of the three funds, whereas fund A having the highest positive volatility and the lowest negative volatility is the least risky, and fund B lies in between.

An investor should look for a fund that has a high positive positive-correlation, meaning the fund moves up when the benchmark moves up, and a low negative negative-correlation, meaning that the fund moves up when the benchmark moves down.

Debunked myth #2: A high global correlation of a crypto fund to a benchmark doesn't necessarily mean that the fund will move in sync with the benchmark most of the time.

Comparing the risk metrics of traditional hedge funds and crypto fundsNow that the main die-hard myths about fund metric analysis have been debunked, another misleading analysis aspect of crypto funds is to compare the metrics side by side with the well-known metrics of traditional assets.

A 40% drawdown for a crypto fund can be "Equivalent" to a 15% drawdown for a traditional fund, but the crypto fund lost is nevertheless more than the traditional fund.

This is part two of a two-part series on how to sort crypto funds - read part one with an overview of the main types of crypto funds here.