5 Different investment fund strategies
There are currently five types of strategies that investment funds in the cryptocurrency space use. Each one of them has its own benefits and risks. Especially for people that are new to investing in cryptocurrencies (digital assets) and do not have the required knowledge yet to directly invest into projects themselves, these funds could be great alternatives as professionals make the investment decisions.
Buy and hold
The most well known is probably the buy and hold strategy. Fundamentals are the most important aspect of the selection process here. Investment managers look at the tech behind the projects and the potential to grow, which they expect to translate in a higher digital asset price.
A long breath is required for those that want to invest in this type of fund as the cryptocurrency market is still in its infancy and most projects are relatively young. Mass adoption is still the goal but is not expected to be achieved in the short term. It could take years for projects to build the exact product that they envision, after which they still have to acquire the right user base. Then there is also the heavy influence that the sentiment within the cryptocurrency market has on each project. Because of this, there is a high risk associated with these investments. But due to the high potential returns these investments may bring, investment funds with this strategy still attract a lot of investors.
The strategy is passive, but the fund can decide to abandon or add new projects whenever they feel is right.
The venture capital strategy closely resembles that of the buy and hold fund. Both have a focus on fundamentals with a long term vision. However, there are two major differences between the strategies. Whereas the buy and hold fund buys its digital assets on the open market, the venture capital fund tends to invest in projects when they do not have any digital assets on the open market yet as they try to get in at an earlier stage when the projects have less funding.
The fund is often actively involved with the strategy of the projects and tends to receive equity in the company as well as digital assets in return for its investments.
Due to this approach, venture capital funds invest for longer periods and endure more risk than a buy and hold fund as there is a higher chance that the project will fail. However, this is also what enables it to generate much higher returns in case of a successful investment.
Another passive investment strategy is the index strategy. It closely resembles an Exchange Traded Fund (ETF). Fund managers have a list of criteria with which they pick a number of digital assets to create an index that their clients invest in, much like investors buy an ETF on the open market. The digital assets of which its index will consist could depend on the following criteria:
- Market cap
- Technology (for example, Proof of Stake only)
The index itself could have the following rules:
- A fixed amount of projects at any one time
- Investment could be weighted more heavily towards certain projects or distributed equally
More often than not, the index will be assessed once a month to see if adjustments must be made in its contents. However, other time periods are possible as well.
With the index strategy, the fund itself does a lot less with regards to fundamental analysis and merely groups certain projects to make it easier for individual investors spread their investment within a certain sector for example. More due diligence is required on the investor’s part here which could make this a riskier investment. However, since this strategy is so passive and thus require less work by the fund itself, the fees for funds that provide this strategy are often a lot lower than other funds.
With the actively traded strategy, the goal is to deliver more consistent returns than if the investor merely bought Bitcoin or invested in an index. By searching the markets for digital assets that are ready for an upside move by either performing fundamental analysis, technical analysis, or a combination, the fund manager aims to find the digital assets that it believes will see a strong move in the near future while attracting a good risk/return ratio.
This strategy can be used by long-only funds or long/short funds. The major benefit of the long/short fund is that it can generate a profit in both bull and bear markets whereas the long fund can only profit from upward moves but will likely have a higher return in bull markets because of this.
The risk profile is highly dependent on the specific strategy of the fund. But overall, the goal is to bring more stability in the returns compared to the market, making it more suitable for short-term investment.
Algorithmic trading is done by, as the name suggests, algorithms. There are a variety of strategies that can be utilized by algorithms. Some of which, along with their risk profile, are:
- Trend following
- Market risk
- Based on indicators
- Market risk
- Risk-free (goal)
- Operational risk
- Market making
- Limited market risk
- Volume risk
Returns of algorithms that are based on indicators or follow the trend are still heavily exposed to the overall sentiment of the cryptocurrency market. Therefore, they are still extremely risky as the cryptocurrency market is quite volatile.
The goal of arbitrage trading is to be risk-free as the algorithm seeks to exploit inefficiencies in the market. At the same time, profit size is often limited. So this strategy would be best for those that believe that consistency and safety is extremely important, even if it severely limits their investment yield. But keep in mind that while trading risk-free is the goal, this does not guarantee that the execution will be as expected. There is always some form of risk known as operational risk, which occurs when the code is not quick enough or if the fund temporarily loses its internet connection and gets stuck in positions.
Market making has some market risk, but far less than the other investment strategies. Those that use this strategy aim to capture changes in spreads within a very short timeframe. This can be either in the same market or in different markets. The nature of the strategy also exposes it to volume risk as it needs liquidity to quickly enter or exit positions after small price changes. Due to the extremely small price changes this strategy actively tries to capitalize on, this strategy can be beneficial in bull, bear, and sideways markets. The most upside is still expected in bull markets as the market maker accumulates more of both sides of the pairs. So in the case of BTC/USD, more USD is accumulated as well as Bitcoin.
Research before you invest
As you can see, there are plenty of strategies to choose from. Investors should know the benefits and risks associated with each of the strategies and check whether these align with their own investment goals.