Jeff Dorman, CFA is a Co-founder and Chief Investment Officer at Arca–an innovative digital asset investment company that combines traditional finance with blockchain technology to offer SEC-registered, 40-Act and hedge fund investment products to institutional and retail investors.
Jeff spoke exclusively to BEQUANT, discussing a day in his life post covid-19, how a typical day at Arca unfolds and what the future holds for digital assets in this evolving financial paradigm.
What is usually the first thought that goes through your mind each morning?
Contrary to what one might think, managing risk in a 24/7 traded asset class does not require 24/7 trading coverage. I do sleep, because we plan for outcomes before they happen and know how we will react if it does happen. But the first thing I do every morning is check the price of Bitcoin, US equity futures, and read the internal recap on Slack from my overnight trading team to catch up on what happened while I slept. Now, BTC itself is not a huge component of our portfolio, but it’s typically a good risk and sentiment proxy for the market. Next, I go through our risk analytics report, and write an update to our risk committee explaining our beta, VAR, overall positioning, and any exogenous risk factors. Our risk committee is made up of non-portfolio team members, and they pushback on our decisions — it is a channel check designed to keep the portfolio team from confirmation bias. After that, I spend an hour with my kids and let my team do their jobs until I get to my office for meetings, calls and investment committees. And of course, we are always reacting to hundreds of news items and data points throughout the day.
How much have things changed for a CIO as a result of the COVID pandemic?
Not much actually, other than an increasingly attractive investment opportunity set and a lot more investor interest (and thus meetings/phone calls with prospective investors). Arca continues to operate in the same fashion as we always have. While we prefer to work together in one location, we’ve had systems and policies in place around research, risk and trading coverage since inception, which has not changed despite the increased volatility and social distancing. We were set up to run virtually at any time already; a byproduct of digital assets markets being open to trade 24/7 and it being impossible to work from an office at all times anyway.
Aside from trading, what other duties take up the bulk of your workday? And which one do you think is most important?
I don’t trade much at all. The roles of CIO, research analyst and trader are all very different jobs for a reason. Analysts shouldn’t be clouded by price action and day to day volatility, traders shouldn’t be too wedded to fundamentals, and the CIO needs to be able to act clearly and rationally to ensure that all investment ideas and positions fit within our thematic focus and our risk parameters. I give my team a lot of rope — they are the smart ones constantly sourcing and evaluating ideas. My job is to be the symphony maestro and simply make sure it all works well together, within the parameters of our mandate and overall objectives and outlooks. As such, I spend a lot more time articulating what we’re doing to investors, and writing about our viewpoints, than I do coming up with investment ideas. Generally, I think about the big picture while my team thinks about individual ways to express the big picture ideas. The most important part of my role is constantly challenging my team, without discouraging them when ideas don’t make it into the portfolio. Investment committee can be a bloodbath — it’s not friendly, and it can be frustrating. It is our job to poke holes in every thesis, to ensure that the investment idea is sound. But we have a rule that you can be as tough and critical as you need to be in the investment committee, while still respecting each other and being friends outside of committee.
We often hear hedge fund managers talk about volatility being an opportunity, where are you seeing the most opportunity these days?
The digital assets space is new, and constantly evolving. As such, identifying value is far more important than taking advantage of volatility. What volatility does provide is the opportunity to resize positions according to risk/reward, and create liquidity for entering and exiting positions. As a result, sometimes you can make money 2-3 times on the same idea. But volatility traders often don’t care about the underlying assets, as long as they are volatile and their movements can be predicted and quantitatively modeled. That strategy works independent of the asset class. We see the value more in the growth of certain parts of this asset class.
You’ve talked in the past about how digital assets are similar to high-yield bonds, do you still believe this is the case?
Yes, though I’d go even deeper than just High Yield bonds. I think digital assets now look a lot like the overall Fixed Income market. If you told someone “I’m a fixed income investors”, they’d likely ask you “Which part”? There are so many different types of fixed income securities from government, municipal, investment grade, high-yield, distressed, asset-backed bonds, to their unique features (callable, put-able, convertible, sinkers, bonds with warrants) to the way in which you value the bonds (duration, convexity, recovery value). Clearly a “one size fits all” investment framework would not be prudent for such a complex asset class. Similarly, the digital assets ecosystem has evolved from the early days of simple homogenous “currencies” to an ecosystem now worthy of its own long explanatory handbook. We can now invest in, and utilize, digital assets issued by faceless entities, decentralized projects, digital asset corporations, traditional non-crypto companies, individuals and soon-to-be governments. The investment vehicles consist of SAFTs, private tokens, public tokens, DAOs, and digital debt and equity instruments. We have tokenized time, predictions, basket tokens and NFTs. Some digital assets are true utility tokens meant for a targeted use case on a specific platform. Others are quasi-equity/quasi-utility tokens with amortizing features, dividends or buyback/burn mechanisms. And, of course, we’ll eventually need a whole chapter dedicated to security tokens, which one day will look more like straightforward financial instruments.
You’ve also talked in the past about the need for institutional-level service providers, where do you think the most progress is being made to solve this problem?
The good thing about a growing asset class is that there are often more service providers than there are people to service. There has been tremendous growth, but also consolidation. Just about everything that used to be a concern for investors in digital assets has now been solved for both from a reputational standpoint (with players like Fidelity getting involved) and from a technology standpoint. Custody, best execution, risk analytics, fund administration, fund auditing, compliance and legal have all seen strong advancements. The one area where there still is not a strong solution is prime brokerage, though there is a large push right now from some of the bigger firms to tackle this.
What excites you most about cryptocurrencies and digital assets?
Probably your question. The fact that you separated “cryptocurrencies” from “digital assets”. They are very different, and most people still do not know this yet. And the digital asset investable universe is growing leaps and bounds ahead of your legacy and traditional cryptocurrencies. The shift to a digital world was already happening pre-COVID19, but the acceleration is definitely happening because of it. The idea that an investable asset can be both a utility and an investment at the same time will change the course of investing and company formation forever. Here’s an example: Everyone has an Amazon Prime membership at this point, and everyone pays the same price for it. When you purchased your Prime membership, you did it to get faster and cheaper delivery, but now you get movies, music and Whole Foods benefits. As a Prime member, you are reaping the benefits, but as an investor, only AMZN shareholders benefit. But what if there was a limited supply of Prime memberships, and if you were an early adopter, you gained both financially from the increased demand AND you gained as a customer from the utility? Not to mention, you’d probably be a strong evangelist as you are incentivized to get others to join. This is where we are headed. Every company is going to soon realize that Digital Assets are a new part of the capital structure. Your Debt, Equity and Digital Assets will all have a place in an investor’s portfolio, and more importantly, in your customer’s portfolios.