The Investment Account was initially set up with the mission to preserve the DAO’s capital and minimize the risks of holding our own governance token during periods of severe market drawdowns. While this goal makes sense, we believe it is just one component of what the Investment Account could be.
The Index Coop community treasury has grown from $3M at the start of the year to over $70M today. As we grow, the TWG believe that our initial goals should be expanded to take advantage of our larger size. We’ve now successfully funded and developed a framework for managing the Operations Account and believe it is ready to begin accepting and managing capital there. That leaves us with the Investment Account. This post serves as an overview of the Investment Account framework.
The TWG recommends the Investment Account be divided into two strategies, with the assets of each strategy held in the one account.
- Diversified Asset Allocation Strategy - This strategy aligns with the original intent of the Investment Account. Any assets dedicated to this strategy will typically be passive-style investments (potentially coupled with more active yield-generating strategies) with the ultimate goal of assembling a diversified portfolio to reduce idiosyncratic risks, preserve capital during market drawdowns, and generate capital appreciation.
- Ecosystem Development, Strategic Investments, and Partnerships Strategy - These alternative-style investments will be made with the goal of projecting Index Coop’s vision and values into the broader ecosystem. Investments might be made to form DAO-to-DAO alliances, invest in relevant infrastructure to Index Coop products, create brand awareness, increase our products user-friendliness, and more. We believe there are plenty of opportunities to make these kinds of investments that don’t rely on typical risk/reward modeling since they offer intangible benefits beyond financial returns.
It is important to note that we could further expand the list of strategies in the future if the community elects to do so. Here our goal is to identify two strategies available to us now that we think are suitable for the Investment Account today.
In the following sections (Diversified Asset Allocation Details and Ecosystem Development, Strategic Investments, and Partnerships Framework), we review each of these two strategies in greater depth.
The TWG would like to present an ideal strategic asset allocation to strive for within the Investment Account’s Diversified Asset Allocation strategy.
Knowing DeFi is a fast-paced industry that is constantly evolving, we understand that these targets will be subject to change as conditions evolve. For each identified sub-asset class, we briefly describe what it is, target ranges we would prefer within the account, any special considerations that should be taken into account, and an appropriate performance measurement benchmark. Again, this list is not rigid and innovations within DeFi may blur the line between sub-asset classes. It will be our job as the TWG to review potential additions to the portfolio on a case-by-case basis.
The following candidate sub-asset classes are considered for representation within the investment account.
- Description: Stablecoins and Equivalents will consist of assets that have stable risk profiles and are generally pegged to a specific value. LP tokens that consist of stablecoin pairs will be considered part of the stablecoin allocation since their risk profiles are similar. The investment account can elect to be exploratory in it’s stablecoin allocation as the Operations Account is tasked with conservatism for this asset class.
- Special Considerations: Yield farming will be allowable, although a preference will be given to passive investment strategies.
- Performance Measurement: PAY
- Description: The Ether asset class will consist of ETH and highly correlated derivatives, such as staked ETH. A preference will be given to productive assets, although a portion will be held unproductive for gas costs, liquidity, and to limit smart contract risk corresponding to staked derivatives. LP tokens that consist of ETH and ETH derivative pairs will fall under this category if one part of the pair is another ETH derivative or a stablecoin.
- Special Considerations: Since Index Coop accrues leveraged ETH, leverage is permissible assuming the position is within the guidelines after accounting for gross exposure. Preference would be given to combining leveraged positions with the non-leveraged asset to reduce total leverage while capturing an additional yield, or avoiding use of leverage entirely.
- Performance Measurement: ETH
- Description: Wrapped Bitcoin will include any wrapped derivative of Bitcoin with a preference toward yield-generating applications. LP tokens that consist of a BTC derivative and another BTC derivative asset or stablecoin will fall under this category.
- Special Considerations: Since Index Coop accrues leveraged BTC, leverage is permissible assuming the position is within the guidelines after accounting for gross exposure. Preference would be given to combining leveraged positions with the non-leveraged asset to reduce total leverage while capturing an additional yield, or avoiding use of leverage entirely.
- Performance Measurement: wBTC
- Description: The Decentralized Finance sub-asset class will consist of DeFi governance tokens and their yield-generating variants. LP tokens where a DeFi governance token is a part of the pair will fall under this category.
- Special Considerations: A preference will be given to productive assets where possible, and holding our own products such as DPI. Leverage is permissible assuming Index Coop elects to accrue leveraged DPI in the future similar to the above.
- Performance Measurement: DPI
- Description: The Metaverse sub-asset class will consist of Metaverse tokens and their yield-generating derivatives. LP tokens where a Metaverse governance token is a part of the pair will fall under this category.
- Special Considerations: A preference will be given to productive assets where possible, and holding our own products such as MVI. Leverage is permissible assuming Index Coop elects to accrue leveraged MVI in the future similar to the above.
- Performance Measurement: MVI
TWG will recommend new asset classes as they emerge to the community, and the community can vote on inclusion via IIP.
In the analysis that follows, we use USDC as a representation of stable coins, DPI for the DeFi universe, and MVI for the metaverse allocation.
The following plot shows the annualized return % and standard deviation of return for the assets under consideration. In effect, it outlines the volatility of the returns and provides a high level view of whether returns compensate for the high volatility. The annualized returns are derived from the geometric mean of monthly returns. INDEX token performance is shown for comparison purposes. The price history used to derive this data begins with the start of INDEX token i.e. Oct 20. The only exception is MVI which began trading in Apr 21.
The below table shows the correlation coefficients between sub-asset class proxies since the inception of MVI. This analysis highlights two important points:
- There are some diversification benefits of allocating toward other risky crypto assets, such as ETH, BTC, and DPI.
- The most immediate diversification benefit will come from allocating to stablecoins.
Figure - Correlation data based on monthly returns
Based on the covariance of the historical asset returns of the various constituents, we perform a trade analysis to identify the optimal allocation that provides the maximum return for a range of volatility. Then, as a next step, we make a determination of the appropriate level of volatility and the corresponding portfolio allocation.
The following plot shows the efficient frontier for portfolio allocation consisting of MVI, DPI, ETH, BTC, and USDC, with constraints that limit the maximum allocation to 50% and minimum to 5% for any individual asset except DPI & MVI. Both DeFi and metaverse projects and their tokens have a short history of utility, user traction, and token price. With that in mind, their allocation is restricted between 5% to 15% of the total portfolio. The efficient frontier for portfolio allocation is defined as the allocation that provides the highest return (shown on y-axis) for the volatility level (shown on x-axis). All performance numbers are annualized %.
To highlight the efficient frontier, performance is shown for 300 random portfolios with random allocations of the constituent assets following the same constraints as outlined above.
Sample portfolios, their constituent allocation %, and expected return/volatility are included for the following two cases -
- Maximum sharpe ratio portfolio
- Minimum variance portfolio
Maximum Sharpe Ratio Portfolio
Minimum Variance Portfolio
The TWG recommends implementing the Maximum Sharpe Ratio Portfolio for the Diversified Asset Allocation strategy. This strategy maximizes return per unit of volatility, in line with the goal of capital appreciation. Funds allocated to this strategy from the broader treasury will be divested into the allocation framework above (this can be managed over time for larger required divestments).
Ideally, the Investment Account will also be rebalanced if an asset class deviates from our defined weighting outlined in the strategic asset allocation and results in a weight that exceeds 75%. Rebalancing will be handled by the Treasury Working Group, and discretion will be used to minimize the frequency of rebalancing during periods of market volatility. The end goal will be to maintain target portfolio allocations over the medium term. Outside of threshold-triggered rebalancing, the mean-variance optimization will be updated on a quarterly basis and the portfolio properly adjusted to account for new target weights.
At this time, we are requesting feedback and questions from the broader community. If the community agrees with implementing the Maximum Sharpe Ratio allocation, we will follow up with an exact implementation plan to begin contributing capital to the account.
Ecosystem development, community partnerships, and strategic investments (henceforth collectively referred to as Alternative Investments) will ultimately result in an accumulation of governance tokens or other assets in the community treasury. While the community should always have the final say (via IIP) on how we go about acquiring, deploying, or liquidating these assets/strategies, the TWG believes that we should collectively develop a coherent framework through which to analyze these types of investments. The goal of any investment should be to align with the treasury strategy while simultaneously reflecting the Index Coop’s ethos and vision.
This post will serve as an initial draft of this framework solely from a community treasury perspective.
Compared with traditional investments, alternative investments often have lower liquidity, asymmetric risk/return profiles, and/or intangible benefits. For this reason, traditional risk/return measures likely provide an inaccurate picture of the investment’s characteristics. Instead, these types of investments should be assessed qualitatively via a robust due diligence process. As part of this process, the impact to the overall portfolio composition of the treasury will be considered but will not be the only factor.
In order to properly constrain the impact on the risk/return of the total portfolio, the TWG recommends that these types of alternative investments be carved out of the Investment Account’s portfolio at a defined allocation threshold. In other words, these investments should remain below a certain allocation of the total treasury and their performance will be secondary to their economic benefits. This will help to avoid over-exposure to what may be illiquid, concentrated, or otherwise riskier strategies, but still give us the ability to execute on these strategy-focused investments that might not fit into our more-formal asset allocation framework.
As an initial starting point, the TWG recommends total strategic investments of this sort be constrained to a maximum of 30% of the total community treasury (as of writing, this amounts to $22.5mm) at time of investment with a preference for a maximum allocation of 5-10% per investment to ensure investments are meaningful in size yet not overwhelming. Note that this does not mean we recommend deploying this capital immediately. Instead, this is provided as a total constraint for risk management purposes and each investment of this type will come with an IIP request to move funds from the Treasury wallet to the Investment Account. Any assets that must be held by the community treasury for these types of strategies will be held within the Investment Account and reported separately from the diversified passive investment portfolio. Performance will be reported on these assets, but it will not be the primary focus.
The TWG believes that DAOs operate best when strategic decisions come from the broader community. As such, we are open to proposals on how Index Coop could deploy balance sheet assets to strategically invest, partner, or otherwise develop our ecosystem. Proposals made to the community will be assessed by the TWG, and we will offer recommendations to the community based on our analysis. Factors to be considered include, but are not limited to:
- Expected intangible benefits to the Coop (e.g. a long-term partnership with a mutually-aligned DAO, increased awareness/usability of our products,etc.)
- Lock-up / Expected timeframe for which the assets will be held
- Reputational/brand considerations
- Sustainability of the strategy
- Total allocation requirement (i.e. how much of the portfolio will be contributed to this single investment)
- Risk/return characteristics of any held assets independently and in relation to other assets held within the treasury
- Underlying liquidity, if applicable
To kick-off this program, we are announcing that we are open to begin reviewing requests from the broader community and ecosystem, and we plan to offer our own proposals as they arise. We are not in a rush to deploy capital, instead preferring to execute on high-quality investments as they come up, but we do want to stress that we are open for proposals at this time, and that we believe this is an excellent use of the community treasury. Not only will we begin diversifying our treasury through these initiatives, but we will also be deploying capital to benefit the Coop beyond just a simple investment return.
We are soliciting feedback from the broader community on the above strategies. Please provide thoughts/concerns/questions below since we hope this to be a community-led initiative. If the community believes the above approach is suitable, we will follow up with specifics on deploying capital to the Diversified Asset Allocation strategy in a follow-up post.