After an exciting time in early November 2021, the enthusiasm in markets faded quickly. The newly found strain of Covid-19, called Omicron, caused a minor shock to markets. Apparently, it seems to be milder than for example the delta variant, but it spreads even faster. Nevertheless, any conclusions on the virus strain are too early to be reliable. Omicron further worries European countries, as their number of cases has been surging regardless of the high vaccination rates. Many countries are imposing further restrictions, after some travel bans have been initiated. Those have not proven to be effective, as Omicron has been detected in most countries already. Among the strictest countries is Austria that has announced that the vaccination is mandatory as of early next year. Despite this rather grim outlook before Christmas, equity markets only took a slight hit. Figure 1 shows the value of the S&P 500 over the past three months. Even though Covid-19 is again a major topic, the drop was only minimal. Equity markets still had a stellar year. The S&P 500, for example, is up 23.4% as of the time of writing. The SMC Equity Strategy Index is up 10.7% in 2021 and gained remarkable 4.16% in October 2021. Major contributors were the strategies Long/Short US Equity Consumer, TMT, Healthcare and Long/Short US Equities Disruptive Technologies with 9.33% and 9.50% in October 2021. The situation looks a lot worse for oil. WTI crude oil lost almost all gains from the past three months, as shown in Figure 2. Oil prices fell from almost $85 per barrel to $66 per barrel. This strong decline stems from the fear of excess supply, if Omicron should lead to more severe restrictions, such as lockdowns. Regardless, oil still has come a long way from its negative value back in March 2020 when Covid-19 became problematic. At the current price of $66 per barrel, oil is up 33.5%, which is still remarkably lower than its previous peak of 67.0%.
Hedge funds experienced a great Q3 2021 and October 2021, as the average fund gained 1.68% and the majority achieved profits. In particular discretionary macro hedge funds gained substantially and according to JPMorgan the outlook for 2022 looks exceptionally promising for macro hedge funds. The market ecosystem is favourable, as there is considerable volatility in the market. A large, and concerning, driver is inflation that keeps rising for the entire year, although it was not a widely discussed topic at the beginning of the year. In November, the US CPI reached a new 30-year high after having stabilized since summer 2021. Figure 1 shows the US CPI and US Core CPI since 1990. Both indicators are at levels last seen around 1990s, which is quite worrying, as during the dot-com bubble and the global financial crisis, the CPIs did not spiked as much as they do now. Even more worrying is the fact that inflation is only expected to drop in summer in 2022, although this threshold has continuously been postponed, as the anticipated peaks have. A large contributor to this development are the interventions of the Federal Reserve, as shown in Figure 2. Not only has the Fed printed substantial amounts of money to fight the economic damage of Covid-19, but it also used quantitative easing to a huge degree. The balance sheet of the Fed grew from $732bn in 2002 to $2.2tn in 2009 and to $8.6tn in 2021. The increase in 2020 exceeds $3.1tn, which is more than the total balance sheet was after the financial crisis in 2007/08. This further emphasizes the degree of the intervention of the Fed. In the UK, the situation does look slightly better. This can be largely attributed to the lesser intervention from the Bank of England (BoE). Although the percentage increase is similar, the assets of the BoE “only” increased by £0.5tn and are currently at £1.07tn, as shown in Figure 3. Currently, inflation in the UK is only at 2% but it is expected to rise during 2022. In August 2021, the estimated peak was at 4%, while in November 2021, this was corrected to 5%. Unfortunately, this has been a general trend in 2021. Hence, it can almost be expected that these estimations will rise going forward.
Hedge funds have experienced a great third quarter and continue to do well in October 2021. Partially due to the surge in volatility, the hedge fund industry is close to reach a milestone of $4tn in AuM. Nevertheless, the strategy of hedge funds is of utmost importance when determining how well a hedge fund is doing. This is in particular true for 2021. Crypto and equity hedge funds tend to profit the most from the current market ecosystem, as their asset class is surging at a rapid pace. Global macro and fixed income-based strategies have a more challenging ecosystem. Figures 1 to 6 show the returns as of Q3 2021 of the different SMC Strategy Indices in comparison to other relevant benchmarks for the specific strategy. Cryptocurrency strategies unsurprisingly did the best this year with the average strategy being up 177%. All strategies in that area cover the best performing strategies of the year with Token Liquid and Token being the best among them with a performance of 316% and 260%. The SMC Equity Strategy Index achieved a lower return than some of its benchmarks in 2021 with 7% as of Q3 2021. The best performing equity strategy is Equities US Activist Event Driven which is 27% up in 2021. With regards to the less beneficial ecosystems for fixed income and global macro related strategies, the SMC Strategy Indices did well. The SMC Credit Strategy Index is up 4.49% an outperforms almost all benchmarks shown in Figure 2. The situation is even better for the SMC Global Macro Strategy Index that achieved a YTD of 37.40%, thereby outperforming any benchmark by a lot as shown in Figure 4.
The most noteworthy event in September 2021 was probably the apparent collapse of Evergrande, one of the largest real estate companies in China, whose status is currently unknown. On Thursday, 16th September 2021, Evergrande issued a statement that it will not be able to repay the outstanding interest payments that day. Following this announcement, the financial market was in substantial stress. Equity markets all around the world lost a few percentage points and volatility spiked. Bond trading was under pressure as well, as Evergrande’s bonds were downgraded and frozen from trading. It sometimes was already referred to the next “Lehman Brothers” case. The volatility the stock has seen since is tremendous, as it lost nearly 80% in the first few days after the announcement. It seemed as though the situation had stabilized, but since not all due payments were paid on Friday, 24th September 2021, the status is unknown. If nothing else happens, which is highly unlikely, the company would enter a grace period following bankruptcy. There are three critical features involved in Evergrande. Firstly, China and Chinese people are heavily engaged with the company, as the company has sold many buildings already without having built them yet. A default would cause huge issues for the affected people. Secondly, many companies are frequently doing business with Evergrande, in particular construction, design and other suppliers, could also face bankruptcy alongside Evergrande. Lastly, the collapse of Evergrande would pose a substantial risk to the financial system of China. The latter one is in particular difficult, as the company has outstanding debt at more than 250 banks, which could put additional pressure on China’s ability to offer cheap debt, which is necessary to maintain growth level. Moreover, it does not make a China a more appealing place to invest for foreign investors, which were already on the decline since the recent developments
In such a highly uncertain environment, cryptocurrencies tend to thrive. Since the middle of July 2021, cryptocurrencies have performed very well. In particular applications on layer one chains, such as Bitcoin (BTC) and Ethereum (ETH), surged during this time. These applications can be split into several categories. These include for example, decentralized exchanges (DeX) and decentralized finance (DeFi). DeX’s are on the rise and are continuously optimized. At the current time, Uniswap v3 is the DeX with the largest trading volume ($800m in 24h), followed by PancakeSwap v2 with around $378m in 24h. In total, 10 different DeX’s have a daily trading volume exceeding $100m. These numbers are quite impressive given that centralized exchanges are young themselves. Binance, by far the largest cryptocurrency exchange, has a daily volume of $23bn. Coinbase, probably the most famous one due to going public, only has a daily volume of around $3bn. DeX’s have two major advantages compared to centralized exchanges. They tend to be cheaper, as only the gas for the transaction needs to be paid and they typically have no downtime, which occur quite frequently for centralized exchange in highly stressed environments. Yet, DeX’s remain a relatively small proportion of cryptocurrency exchanges. Over the last months, FTX was the most talked about exchange for several reasons. FTX is a cryptocurrency derivatives exchange and made headlines with its last funding round. FTX raised $900m and is now valued at $18bn. This is especially remarkable, as the company was valued at $1.2bn a year ago. Furthermore, there is barely any day without announcement about their attempt to increase their brand awareness. Tom Brady, Gisele Bundchen and Stephen Curry are just some brand ambassadors. They have also secured the naming right for stadiums, e.g. the Berkeley stadium, and have entered a multi-year sponsorship deal with the famous e-sport team TSM. Despite the significant spending on their brand awareness, the public seems to react well to their efforts, as their token (FTT) has reached a new record high, as shown in Figure 9. Another significant player among cryptocurrency exchanges is Bakkt, the first exchange that offered physically settled BTC futures and options and being owned by the Intercontinental Exchange (ICE). Although, it is known that Bakkt will go public since January 2021, it is widely anticipated that this should take place relatively soon. It is certainly interesting to find out where the second cryptocurrency company will end up after its SPAC listing valued at $2.1bn. The other category mentioned previously, DeFi, is more well-known since its application are very diverse. DeFi is typically measured by the total value locked (TVL) in DeFi, which is shown in Figure 10. Shortly before the most recent crash, TVL reached almost $100bn. At the time of writing, TVL is around $87bn. This is remarkable as at the beginning of 2020, TVL was only several million. Yet, the metric is not entirely transparent and various sources claim hugely different values. The issue with the metric is the tracking of the capital committed, measured by the collateral to make decentralized applications (DApps) comparable, as some of them are levered. But the measurement of TVL is difficult for several reasons. Firstly, the measure counts all values of different chains and the respective sub-chains. As they launch frequently, there can be mismatches. Secondly, various DApps allow all kinds of collaterals and those can be traded centralized, on-chain or off-chain, which makes their aggregation difficult to track. Lastly, value locked may be misleading, since liquidity can be added and removed very quickly, which poses additional tracking difficulties. DApps in DeFi also have the potential to revolutionize the traditional banking system, as basically any function from traditional banking is already available as DApp. Many early DApps focused on payment solutions, as many see the current payment methods
from the banking system as flawed in particular cross-border transactions, the time they require, and the fees associated with transactions. There are also many non-blockchain based solutions out there already with online banks, such as Revolut, or Wise that recently went public. Newer DApps started focusing on the lending function of the current banks. At the current stage, most capital in DeFi flows into such lending applications. The most valuable ones are Aave, Maker and InstaDApp, which all have around $13bn value locked in the application. InstaDApp is an asset management platform for DeFi platforms. It makes transactions between DeFi platforms easy, and it does not trigger fees, except the gas costs for the movement of assets. InstaDApp has now fully issued their token (INST). The price development of INST is shown in Figure 11.