How did Grayscale grow its AUM so fast?

When I write this, Grayscale Investments has about $9.8 billion in Assets under Management. This undoubtedly makes Grayscale one of the fasted growing asset management companies in history.

Established in 2013 by Digital Currency Group, Grayscale operates trusts that allow investors to invest in various cryptocurrencies. Trusts are open-end, which means that the number of units will change as investors move in or out of the funds.

The units in the Grayscale Bitcoin Trust (GBTC) and the Grayscale Etherium Trust (ETHE) are that are quoted on the OTCQX market. Both trade at a significant premium to the net asset value (NAV) per share. That in itself is intriguing, since Grayscale charges a 2% management fee on assets.

Why does the Grayscale Bitcoin Trust exist?

The Grayscale Bitcoin Trust is passive, as opposed to being an active fund. The investment policy is simply to hold Bitcoin. Passive funds are usually set up to track and index or some other benchmark. So you might ask yourself what is the point of setting having a fund that only holds one asset?

Why would somebody buy this as opposed to buying the underlying asset directly? How come that investors are willing to buy Grayscale Bitcoin Trust units at a premium to Bitcoin per unit and pay Grayscale a 2% annual fee, instead of just buying Bitcoin directly?

The answer is two-fold:

  1. Most institutional investors are simply not allowed to invest directly into Bitcoin. They have a strict mandate on what they are able to invest in. So, they can’t, even if they want to, get exposure to Bitcoin unless it is through a security, such as a trust unit. Eventually, we can expect the Grayscale Bitcoin Trust to convert into an ETF and the management fee to go down.
  2. Most investors into the Grayscale trust are not buying investing through the open market. They participate in something called an Offered Product. Accredited investors participate in the Offered Product and receive an allocation that values the trust units they receive on a NAV-basis, or Bitcoin per share. By participating in the Offered Product, they are also bound to selling restrictions and subject to significant limitations on resale and transferability.

More on Cryptocurrencies

Largest S&P 500 Single Day Drop

One of the things that has preoccupied my mind lately are the underlying differences in approach between active investing and passive investing.

Imagine the two following hypothetical money managers: One of them is an active investor. He performs bottom-up fundamental research of companies, trying to determine their “intrinsic value”.

The other investor is passive. He uses quantitative analysis in order to find factors would have lead to out performance compared to a specific benchmark (these strategies are called “smart-beta” as they are passive in nature, but still aim to outperform the benchmark).

Analytical vs Statistical Approaches

For lack of better terminology, lets say that the active investor has an analytical approach, while the passive investor has a statistical approach.

The active investor is focused on the future cash flows of the company. He is tries to understand the business model of the company he is analyzing how the company creates value. He might try to study historical transaction multiples or how similar public compare in terms of valuation ratios. But primarily, the fundamental investor is trying to analyse future events.

The quantitative investor, however, is looking at a universe of stocks. He mines datasets to find a relationship between factors and performance. He designs different strategies and uses backtesting to see how these strategies would have performed.

The Limits of History

But what is data? Data is history.

Consider the following: Suppose you ask the investors about the largest single day drop in the S&P 500. The quant tells you that the largest single daily drop of the S&P 500 occurred on October 19, 1987, when the index fell by 20.47%.

The fundamental investor, however, tells you that the largest single day drop hasn’t happened yet.