Invictus Margin Lending (IML) – A New Breed of Super Fund

Invictus Margin Lending (IML) - A New Breed of Super Fund

The launch of the Invictus Capital IML fund in August 2019 was met with great anticipation, as the fund’s strategy democratizes access to an attractive niche of the capital market machine.

The fund provides investors the opportunity to effectively take part in margin lending within the digital assets space. The value proposition of margin lending is strong dollar-based returns throughout a broad range of market conditions, with limited capital drawdown risks. The fund’s engine room is a proprietary algorithm that seeks out the best and most efficient margin lending opportunities on the highest quality exchanges.

Traditionally, with specific reference to traditional financial markets such as equity or fixed income, margin lending is a practice only available to large institutions and other big market players. Returns are superior, however, the barriers to entry are high, and incumbents share tight relationships. It is difficult for the individual to get a seat at the table. However, the rise of blockchain and decentralized finance allows others to get in on the action, particularly in cryptocurrency markets.

Margin Lending in a nutshell

Margin trading, albeit a recent feature of cryptocurrency markets, has surged in popularity in recent years. Traders are willing to borrow funds, in the short-term, to leverage their trades and pay lenders high-interest rates for the service. The question is, who would be willing to lend funds to these traders for this seemingly risky bet? The secret lies in the risk management systems designed by exchanges.

A margin trader’s position is automatically closed if losses approach the value of their collateral, so they can never lose more than they put down (in this case, the lender keeps their collateral). This process relies on matching engines that close positions in time to protect lenders. The result is a market where lenders can earn outstanding returns with minimal risk of losses.

Margin facilities are valuable to traders. They can increase exposure without sending all their funds to an exchange, or they can take outsized bets on the direction of the market – amplifying potential returns. A trader aiming to make 10% from one price move will happily pay 0.1% interest daily. The compounded value of 0.1% daily results in a healthy 44% annual return for the lender.

Where the magic happens

Looking back on IML’s performance thus far, the results were a consistent outperformance of the 6% p.a. benchmark. The fund has returned upward of 10.5% annualized, with no drawdown events. This alone does not seem overly dazzling, but the moving parts that are out of plain sight make an IML investment difficult to compete with.

Firstly it is important to appreciate risk-adjusted return. Generally in financial markets, greater return potential comes with greater risk; balancing the risk-return profile is the portfolio manager’s primary job. However, this truism does not appear to always hold in the context of the burgeoning crypto market.

As the fund’s risk/volatility is almost similar to earning interest in a bank account, the ratio of return per unit of risk significantly outstrips most retail investment opportunities over the past year. In a covariance and portfolio optimization exercise, which includes IML and other top crypto assets and alternative investment funds, IML dominates, which suggests making a significant allocation to it as part of a balanced portfolio.

Compared to a similar investable opportunity, the BlackRock High Yield bond fund (similar risk and return features) has a Sharpe ratio of 0.29 and IML produces a Sharpe ratio of 0.97 (using the same risk-free rate). For added perspective, the S&P 500 yielded an average Sharpe ratio of 0.54 over the same period. Another comparable way is to allocate your capital is to utilize peer-to-peer lending platforms, such as Upstart, Peerform, Lending Club, Prosper, etc. These platforms show strong potential returns but are subject to minimum investment amounts, lock-in periods, and counterparty risk.

Secondly, IML provides serious diversification benefits when the uncorrelated nature of returns are considered.  Since IML has no exposure to the market forces of supply and demand surrounding traded assets, it performs well regardless of which direction the market is moving, though heightened levels of volatility in either direction tend to improve fund returns as demand for lending from margin traders picks up (these traders aim to leverage exposure to either the upside or downside). This antifragile characteristic of the fund is key to warranting a place in an investor portfolio, much the same way how most investors allocate a portion of their capital to gold.

Thirdly, the fund’s risks are incredibly low, exposed only to counterparty risk related to the exchanges through which the fund operates. This is largely mitigated by only operating on the highest quality exchanges. IML’s diversification benefits also allude to the anti-fragile nature of the fund, as it actually benefits in times of heightened volatility, when margin traders need to pay-up extra for taking leveraged positions due to the additional risk experienced in the market.

Lastly, the fund is dollar-denominated. The closest comparable investment opportunity with the same dollar-based return and volatility profile would be long-term U.S. deposit account, which can, at best, return about 1% currently in the U.S. With interest rates globally at an all-time low, hoping for a return of 11% and upwards annually would be a mere castle in the sky.

A deposit account is also subject to serious liquidity constraints, as you would need to lock your funds up for a long period of time to earn a reasonable return. The IML fund on the other hand removes the illiquidity factor (and keeps the related premium on returns) as the fund has 24/7 liquidity via the redemption infrastructure on the Invictus investor portal.

The next closest alternative would be an investment in high-yield corporate bonds, however, these are also subject to much higher volatility (due to market forces and sensitivity to interest rate changes) and illiquidity as this market is thinly traded at times. The average yield for these bonds has averaged around 6% since 2016, and the fund uses this rate as a benchmark for dollar based-returns to measure the relative performance of the IML fund – despite these rates having collapsed to around 2% now.

Invictus Margin Lending (IML) - A New Breed of Super Fund

From the graph above it is evident that the IML is showing performance well above the hurdle rate, with a very stable volatility profile. Considering the 24/7 liquidity, dollar-based income and the prospect of benefiting from market volatility (antifragile), IML shapes up to be a new breed of superfund. It could become an undeniable inclusion as a foundation for any portfolio, and it is democratized and available to virtually any investor with no investment minimums.

Images courtesy of Invictus Capital

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