According to a report by CryptoCompare, the total assets under management (AUM) of crypto index funds increased from $130 million in 2019 to $2.57 billion in 2020. This is close to a 20-fold increase in just one year.
As the crypto industry heads towards mass adoption, investors are seeking better ways to get exposure to this asset class. Investing in individual cryptocurrencies can be risky and time-consuming. It requires extensive research and monitoring of the market. Hence, index funds are emerging as the preferred way to invest in crypto.
An index fund is a tool to mimic the composition and performance of multiple assets through a systematic process. Indices are generally used to measure the performance of a certain sector, idea, or theme.
What Are Crypto Index Funds?
Crypto index funds are investment vehicles that track the performance of a group of cryptocurrencies. They allow investors to gain exposure to the cryptocurrency market without having to manage individual cryptocurrencies.
Like traditional index funds, crypto index funds are passively managed. And similarly, they seek to replicate the performance of a specific benchmark index.
For example, The DeFi 10 Coin Set gives you exposure to the top DeFi tokens. This broadly replicates the performance of the Decentralized Finance sector. These tokens can be selected based on their market cap, volatility, fundamentals, etc.
Origin of Index Funds
Index funds, in general, have been around for decades. The first index fund was introduced by John Bogle, founder of Vanguard Group, in 1975.
In the early 1970s, Bogle began to question the traditional approach to investing, which focused on actively managed funds that aimed to beat the market by picking individual stocks. Bogle believed that this approach was flawed, as most actively managed funds failed to outperform their benchmark indices over the long term. He argued that investors could achieve better returns by simply investing in a diversified portfolio of stocks that tracked the performance of a benchmark index, such as the S&P 500.
The idea behind index funds is that instead of trying to pick individual stocks to invest in, investors can put their money into a big bucket that holds a little bit of every stock in a particular group (like the S&P 500). That way, as the overall value of the group goes up or down, the value of the investor’s bucket will go up or down as well. This can reduce risk by spreading investments across a broad range of securities rather than concentrating them in a few individual stocks.
The Rise of Index Funds
Essentially, index funds offer a low-cost and low-maintenance way to invest in the stock market without having to worry about picking individual winners and losers.
As of 2021, the percentage of global investments in index funds compared to mutual funds has surpassed mutual funds for the first time.
According to Morningstar’s Global Fund Investor Experience report, assets in index mutual funds and exchange-traded funds (ETFs) accounted for about 51% of all long-term mutual fund and ETF assets worldwide at the end of 2020. Actively managed funds accounted for the remaining 49%. This marks a shift in the industry as more investors recognize the benefits of passive investing through index funds.
Additionally, index funds often outperform actively managed funds over the long term due to their lower fees and more diversified portfolio. According to a study by S&P Dow Jones Indices, over 90% of large-cap fund managers underperformed compared to the S&P 500 over a 15-year period.
Furthermore, index funds are a cost-effective and efficient way to gain exposure to the cryptocurrency market because they simply seek to replicate the performance of a benchmark index. This requires less research and analysis and thus results in lower fees. In contrast, actively managed funds typically charge higher fees to cover the costs of the research and analysis required to identify and invest in individual stocks. Plus, the transaction fees that are incurred from the frequent buying and selling of asset quickly adds up.
Coin Sets aka Crypto Index Funds
Coin Sets by Mudrex are based on the idea of index funds. These are themed crypto baskets that work on the principle of systematic investing – Diversification, Rebalancing, and Consistency to help you build wealth over the long term.
Each Coin Set follows a crypto market trend or investment idea. For example, DeFi 10 tracks the decentralized finance sector within crypto. Crypto Blue chip, on the other hand, consists of the top five cryptocurrencies by market capitalization. They need not belong to the same sector. However, they are grouped together because of their market cap. In traditional markets, ‘Blue chip’ is used to refer to relatively stable assets.
Why Crypto Index Funds are Better Than Investing in Individual Cryptocurrencies?
The cryptocurrency market is highly volatile, with prices often fluctuating rapidly. By investing in a crypto index fund, investors can get exposure to a well-diversified portfolio of cryptocurrencies. This ensures relatively stable and predictable returns than investing in individual cryptocurrencies that experience wild price swings. Crypto Index Funds function on the same principles as traditional index funds and offer the same benefits, as listed below.
1. No emotions at play, aka passive investing
When you try to time the market or pick individual stocks, emotions like fear/greed often cloud your judgment.
For example, the spread of false and misleading information about a cryptocurrency can lead to panic in the market, and out of fear, you may dump your investments in that crypto without doing due diligence. On the contrary, it may happen that a cryptocurrency might be soaring because of some speculative traders, and greed may lead to you investing in it, too, without checking for its fundamentals.
The passive approach of index funds can help to reduce emotional biases and behavioral mistakes that can come with active management, such as trying to time the market or picking individual stocks based on hunches or rumors.
Index funds help us make rational decisions because they are based on a set of predetermined rules.
2. Regular rebalancing
Rebalancing involves periodically adjusting the portfolio to maintain the desired asset allocation. This means cryptocurrencies are added/removed/weights are altered based on market conditions and the performance of the assets.
This ensures that your portfolio remains diversified and aligned with the initial risk-reward ratio. It prevents the portfolio from becoming too heavily weighted in any one particular asset.
For example, let’s say an index fund tracks the S&P 500, and an investor has a target asset allocation of 60% stocks and 40% bonds. Over time, the stock portion of the portfolio may outperform the bond portion, causing the portfolio to become overweight in stocks. By rebalancing, the investor would sell some of the stocks and use the proceeds to buy more bonds, bringing the portfolio back to the target allocation.
It also helps prevent investors from chasing overhyped trends.
Theme-based investing involves investing in a specific sector in a diversified manner. For example, the NFT & Metaverse Coin Set invests in cryptocurrencies that are building services or products within the NFT & Metaverse space. By investing in this Coin Set, you get exposure to the NFT & Metaverse sector without having to research individual cryptocurrencies.
Coin Sets, on a broader level, also track a particular sector within crypto. If the ‘NFT and Metaverse’ domain grows, the ‘NFT and Metaverse Coin Set’ will reflect that growth. It doesn’t try to outperform the sector through individual cryptocurrencies.
It’s easier to evaluate the potential of a sector than it is to evaluate a particular asset. You can never know enough about a stock/cryptocurrency, but that’s not the case for a sector.
Theme-based investing also allows you to jump onto the emerging trends of the crypto market without always having to be on the lookout.
4. Risk-adjusted returns
Risk-adjusted returns refer to the returns earned on an investment after taking into account the amount of risk taken to achieve those returns. It measures the amount of return an investor receives relative to the amount of risk taken to generate that return.
A healthy risk-adjusted return can be achieved by strategically spreading the risk across different assets. This helps reduce the impact of any single cryptocurrency performing poorly.
For example, if you are solely invested in one cryptocurrency, and it experiences a significant decline in value, your portfolio would be heavily impacted. But if you were invested in a Coin Set, the decline in one cryptocurrency would have less of an impact on your overall portfolio.
Overall, the combination of diversification, regular rebalancing, and passive management help index funds achieve better risk-adjusted returns.
Index funds provide a diversified portfolio of stocks or other assets that track a benchmark index. This helps spread the risk across multiple investments and reduces the overall risk of the portfolio.
For example, if one of the stocks in the index performs poorly, the impact on the overall portfolio is minimized since it represents only a small portion of the total holdings. Conversely, if one of the stocks performs exceptionally well, the impact on the overall portfolio is also limited but still benefits from the overall market trend. This way, the investor is not overly exposed to any one stock and is instead diversified across a broad range of assets. The same applies to Coin Sets.
6. Lower fees
Index funds typically have lower fees compared to actively managed funds because they require less research and analysis by the fund manager. This can result in significant savings for investors over the long term.
The same logic applies to Coin Sets. The fees charged are minimum because the fund is passively managed. Also, it prevents you from paying a lot of fees that you would have otherwise paid when buying individual cryptocurrencies because people often end up trading them. The nature of Coin Sets encourages ‘buy and HODL.’
The holdings of index funds are publicly available and updated regularly, providing investors with a high level of transparency about the underlying assets in the fund.
All Coin Sets disclose their constituent coins and their weightage on the Mudrex app for users to understand where they are investing.
In conclusion, crypto index funds are an increasingly popular investment option. They are an easier way to invest in cryptocurrencies. It also emphasizes the impact of passive investing and long-term wealth generation.