Q&A with Adil Abdulali of Samara Alpha Management

In the aftermath of the crypto meltdown, market-neutral funds are actually generating higher returns now than in 2022 prior to the bankruptcies. Samara Alpha’s select universe of market-neutral crypto funds is a prime example: our pro forma portfolio earned ~6% net returns in the first quarter of 2023, which annualizes to 24%. These managers significantly outperformed FY2022 return of 14% despite ramping up exposure after adjusting counterparty risk management.

What happened? A lot of over-levered players had pushed spreads tighter and squeezed out alpha, and as soon as these non-economic players went bankrupt or left the space last year, the conservative funds that were not chasing yield are having a field day providing liquidity to and extracting returns from a more rational market.

A great example is one type of arbitrage that involves buying and selling the same coin on different venues simultaneously. Given the uncertainty surrounding crypto exchanges, this strategy suffered with Binance and FTX processing the majority of volume in the ecosystem. After these managers shut down or downsized due to regulatory pressure, liquidity began migrating to more venues across the globe with more price discrepancies for funds to arbitrage.

At its core, operational due diligence for cryptocurrencies is widely the same as for traditional managers in that we evaluate their business infrastructure as well as their control and operational procedures. How we determine managers’ experience, commitment to the success of the product, their motivation and incentives to outperform is unchanged across asset classes. Where it differs is the evaluation of specific characteristics of digital asset trading, especially given the regulatory uncertainty surrounding this space. We’re able to apply our knowledge of traditional asset management regulations, risk/return metrics, and qualitative analysis to determine which managers meet our parameters. As experts in traditional asset management, we know what the rules are; as experts in crypto asset management, we know how to adopt the rules to this nascent asset class.

The strategies in our fund-of-funds have existed in the traditional space for decades, but because there are more inefficiencies in this nascent asset class, these crypto strategies are able to generate greater returns over a shorter time horizon. Traditional assets are closed for trading for large parts of the day, while crypto trades 24/7 globally. Systematic strategies that can also trade 24/7, algorithmically executed with human oversight rather than directly traded by people, reap the rewards.

The following are select examples of how we extract value from market-neutral strategies that take advantage of such inefficiencies:

Market-Making:
Conventional players such as Citadel and Jump have been extracting alpha by providing liquidity to the equity and bond markets. Experienced traders have left these shops to apply their honed techniques to crypto order books and flow data to generate significant returns. Since bid-offer spreads in crypto are larger than conventional markets and there are more decentralized venues available to trade crypto, significant profits can be had with less leverage. However, these strategies have lower capacity than traditional assets, resulting in an opportunity befitting UHNW and smaller family offices with allocation sizes in the millions rather than the billions.

Basis Trading:
Futures contracts were initially launched on BTC in the form of perpetual “futures” contracts (“perps”) in 2016 on the BitMex exchange. The CME Group launched these futures in Q4 of 2017. Since then, the chains on which futures are offered as well as the exchanges offering perps have proliferated. Both futures and perps trade at different prices than the underlying assets, allowing for a variety of market-neutral, relative-value strategies for systematic funds to exploit. Although basis trading is done in most commodity / futures conventional markets, the potential spreads in crypto are higher with greater profit available at lower levels of leverage.

Volatility Trading:
Options on BTC, ETH, and other liquid tokens are another source of returns for arbitrageurs. Traders with knowledge of gamma trading, covered option strategies, and index arbitrage in traditional markets who learn the operational and counterparty issues in crypto are rewarded with a rich source of alpha. The cards are stacked in their favor as most crypto native option users are purely speculating and wouldn’t know a Greek if they ran into one in Athens’ city center.

Statistical Arbitrage:
There are many related assets in the crypto space making up distinct cohorts with short-term relative movements to each other, yet move together, in general, with various leads and lags. This is not dissimilar to sector equities in traditional equity markets. Examples include Bitcoin vs. altcoins, and various Layer1 ecosystems such as Ethereum+project tokens and Solana+project tokens. Using very short-term price patterns and flow data, stat arb models lifted from traditional markets make comparable returns in crypto but with a lot less leverage.