At the issuer level, the SEC and individual states regulate investment into the fund by US fund investors. At the adviser level, managers are regulated by either the SEC, CFTC, or neither based on whether the portfolio assets are classified as securities or commodities. These are considered private securities offerings under US law. Digital asset funds have few distinctions from similarly structured hedge funds at the issuer-level. Most of the registration exemption nuances affecting digital asset funds are based on adviser-level issues, where the classification of the portfolio investments is jurisdictionally determinative.
Section 4 a 2 of the Securities Act exempts from registration transactions by an issuer that does not involve a public offering or distribution. Hedge funds and other private funds usually rely on Rule of Regulation D for exemption from public securities offering registration. Rule of Regulation D allows issuers to raise an unlimited amount of capital from accredited investors without registration. Registration exemption is accomplished at the federal level through limited notice filing obligations with the SEC, and at the state level through limited notice filing obligations with the respective states where the investors are domiciled.
Registration exemption requirements are light, provided that investors meet the accreditation standard. The Company Act requires public registration of pooled investment vehicles and imposes substantial compliance burdens on public funds, including liquidity, diversification, and short trading limitations, as well as restrictions on transaction-based compensation, which are unsuitable for private fund managers.
Hedge funds and private equity fund managers typically satisfy the exemption requirements either under Section 3 c 1 or 3 c 7. Section 3 c 1 is for small funds with less than investors. Both 3 c 1 and 3 c 7 are self-executing exemptions and require no overt filings for the exemptions to take effect, so long as the provisions are satisfied. The Investment Advisers Act of governs advisers who provide advice on securities.
As with issuer-level securities regulation under the Securities Act and Investment Company Act, investment adviser regulation under the Investment Advisers Act and applicable state advisory laws has both registration provisions—although certain fund managers may be exempt—and anti-fraud provisions, which apply to both registered and exempt managers. Registration with the SEC would subject digital asset funds to adviser-level registration, reporting, recordkeeping, and SEC examination.
Digital asset funds that trade even minimal levels of securities assets are subject to the investment adviser registration requirements. SEC advisory rules contain no de minimus exemption for the inclusion of insignificant levels of securities assets within the portfolio, as is the case under the CFTC registration and exemption framework. Beyond these two key exemptions, the SEC also offers a family office exemption available to advisers of funds comprising lineal descendant family investors from a shared ancestor.
The stellar returns of cryptocurrency hedge funds have created significant interest from high-net-worth investors, family offices, and a few adventurous institutional investors. Given the high valuations and therefore low expected returns for stocks and bonds, investors are desperate for alternatives. However, many alternatives have historically failed to be alternative enough and provide returns uncorrelated to traditional asset classes. Although the correlation was not consistently low and reached 0.
Essentially this means that these funds represent crypto-currency beta rather than alpha. Comparing the performance of cryptocurrency hedge funds to Bitcoin highlights indeed an almost identical performance. Given the diversity of strategies utilized by cryptocurrency hedge funds, it is somewhat disappointing that on average they provide nothing much but exposure to Bitcoin.
On the other hand, it is the same story for the broader hedge fund industry that has failed to generate alpha. The Credit Suisse Equity Market Neutral Index, which is the adequate index for evaluating the alpha generation of hedge funds, has generated a zero return in the 17 years between its inception in and It was perhaps difficult for some investors to get exposure to Bitcoin before , but since then there have been launches of multiple public instruments like ETFs and ETPs that provide this relatively cheaply to investors.
Source: FactorResearch. Running a hedge fund is getting continuously more challenging as markets have become highly efficient with few arbitrage opportunities left for exploitation. Given this, most hedge funds have started to provide beta exposure, simply as alpha is scarce and stocks have been trending up.
Moving to cryptocurrency markets seems an obvious strategy for hedge funds in search of greener pastures.
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