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The recovery in crypto ETFs has been propelled by putative signs of life in the cryptocurrency market, with bitcoin having rallied 38 per cent by Jan. 27 to US$22,900.DADO RUVIC/Reuters

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A swarm of cryptocurrency-focused equity exchange-traded funds (ETFs) has enjoyed astonishing starts to 2023, chalking up sharp gains rarely seen by diversified stock funds.

The US$3.9-million Valkyrie Bitcoin Miners ETF WGMI-Q led the way with a 101 per cent return since the turn of the year, but a flock of rival funds have also chalked up gains of between 40 and 80 per cent.

Most of these ETFs are still well below water for longer-term investors, having been pummelled by last year’s “crypto winter” and the broader sell-off in technology stocks, but the nascent rally does point to the niche sector’s ability to bounce back owing to its inherent volatility.

The partial recovery has also been echoed, albeit in a more modest fashion, by some technology funds, such as ARK Innovation ETF ARKK-A. It has risen 25 per cent so far this year, putting it on track to potentially record its strongest monthly return ever, having plummeted 75 per cent during the course of 2021 and 2022.

“If you were convinced two years ago by the ARK story, technology is now on sale,” says Kenneth Lamont, senior fund analyst for passive strategies at Morningstar Inc.

The recovery in crypto ETFs has been propelled by putative signs of life in the cryptocurrency market, with bitcoin having rallied 38 per cent by Jan. 27 to US$22,900, after an unusually long period of rangebound trading, having cratered from an all-time high of almost US$70,000 in November 2021. Solana, a smaller digital token, has jumped by 145 per cent.

This rebound has largely been attributed to signs that inflation might have peaked, particularly in the U.S., potentially allowing global interest rates to peak at lower levels and paving the way for more “risk-on” investment strategies.

“These were some of, if not the, worst performing ETFs in 2022, so they can bounce back sharply, in part, because bitcoin and other cryptos themselves have bounced back,” says Todd Rosenbluth, head of research at VettaFi LLC.

“This is why people invest in crypto,” Mr. Lamont says. “For many of the investors who invest in crypto, it’s effectively high-stakes gambling. It’s high risk and potentially high reward.”

Valkyrie Bitcoin Miners ETF has been the best-performing unleveraged equity ETF globally in the first few weeks of 2023, according to data from Morningstar Direct, although it’s still down by two-thirds since its inception in February 2022.

Its largest holdings are cryptocurrency miners Bitfarms Ltd. BITF-Q, Marathon Digital Holdings Inc. MARA-Q and Digihost Technology Inc. DGHI-Q, which have seen their share prices surge between 148 and 279 per cent since the start of January.

VanEck Digital Assets Mining ETF DAM-Q is not far off, with holdings such as crypto miners Riot Platforms Inc. RIOT-Q and CleanSpark Inc. CLSK-Q and Chinese computer hardware manufacturer Canaan Inc. CAN-Q helping to propel it to a 77 per cent gain. The ETF is, however, only back to trading at the levels it saw in early November – it’s still down 76.8 per cent from its March 2022 highs.

The huge rebounds have not been confined to crypto mining ETFs, with VanEck Digital Transformation ETF DAPP-Q – whose holdings include Block Inc. SQ-N, a payments company created by Twitter Inc. co-founder Jack Dorsey, and crypto exchange Coinbase Global Inc. – up by 66.8 per cent.

Global X Blockchain ETF BKCH-Q, Bitwise Crypto Industry Innovators ETF BITQ-A and iShares Blockchain and Tech ETF IBLC-A are also up more than 60 per cent.

Mr. Lamont says thematic funds were known for exhibiting “whipsaw” like returns, though.

“Cannabis has seen some incredible swings in the past and in the post-COVID-19 recovery, some ETFs posted triple-digit returns within the space of a year when things began to pick up again,” he says.

Between April and December 2020, Invesco Solar ETF TAN-A jumped 305 per cent, according to Morningstar data, perhaps the most explosive example of thematic funds’ ability to exhibit stellar gains when markets turn.

Investors have, though, largely stuck with crypto-related equity ETFs and those in the wider technology sector despite last year’s losses, suggesting a degree of resilience.

“Thematic funds got clobbered [last year],” Mr. Lamont says. “Seventy-five per cent have an explicit growth bias and they got hit extremely hard. And yet, we didn’t see a stampede for the door and I found that interesting.

“If you have bought into a fundamental story, the fundamentals of these themes haven’t changed.”

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