GBTC - Top 5 Portfolio Positions Going Into 2024

2023-12-29 13:35:50 ET

Summary

• Top positions for 2024 include T-Bills, municipal bonds, Flow Traders, Pioneer Natural Resources, and Grayscale Bitcoin Trust.
• T-Bills offer a higher yield than bonds and have a lower risk profile.
• Municipal bond funds are trading at significant discounts and offer potential for capital appreciation if interest rates go down.

As we usher in 2024, many people are thinking about change and new opportunities. I'm getting asked for my top positions from time to time. This seems like a great time to go over them. Often, people believe top picks are your highest conviction picks. For me, that's true to an extent, but they also tend to have a lower risk profile compared to smaller positions. When I put this article together, I realized quite a few of the top positions were inherently low-risk or special situations with hedged market risk. That significantly reduces risk as well as return. I really like these for their advantageous risk/return profiles. However, the lower risk/return profile also meant I've been more inclined to upsize these. Picks further down the list may actually have more upside but also have more risk associated with them. Here are the top-5 positions I’m going into 2024 with:

1. T-Bill & Chill

The SPDR® Bloomberg 1-3 Month T-Bill ETF ( BIL ) offers a yield-to-maturity of 5.38%. This paper has minimal risk (credit or interest rate). Yet it pays more than the 10 or even 20-year bond. In bonds, you could make more money if yields go down through capital appreciation. The problem is that you must be right about the direction of interest rates to beat the short-term paper. The CME interest rate tool shows there is 150bps of interest rate cuts expected through 2024. If that doesn't happen, bonds are unlikely to outperform T-Bills. Stocks return quite a bit more on average. The long-term rate of return for U.S. markets is around ~10%. Is the extra 4.6% of average return worth it?

High-yield bonds exemplified by the iShares iBoxx $ High Yield Corp Bd ETF ( HYG ) are a clearer example of the relative attractiveness of T-Bills. This ETF offers a SEC yield of 7.49% vs 5.25% for BIL. It has an expense ratio of 0.49% vs 0.14% for BIL. Is the 2% extra worth all the extra credit and duration risk? The market thinks so but T-Bills look like a great addition to my portfolio.

2. Municipal Bonds

Nuveen Pennsylvania Quality Municipal Income Fund ( NQP ) is a closed-ended fixed-income fund, or CEF. It invests in the fixed-income markets of Pennsylvania. Its holdings are generally tax-exempt municipal bonds with a rating of Baa/BBB or higher. The fund is running at a leverage ratio of 39.77%. It trades at a discount to net asset value of 15.83%.

That is a significant discount for a closed-end fund in general. Municipal bond funds trade at fairly significant discounts currently. In my experience, municipal bond funds usually trade at much narrower discounts. It may have to do with the hiking cycle we just went through and the havoc this has caused in bond markets. Imagine owning leveraged high-duration funds. The fund pays a meager 3.39% distribution and has a market value of $428 million. The expense ratio is 2.93%, but 1.88% is due to leverage costs.

The average portfolio coupon is 4.47%, and the annualized leverage costs are 4.33% based on the last month. This fund is going to do exceptionally well if interest rates go down. It won’t do well if interest rates go up. The leverage-adjusted duration is around 15. I’ve hedged this position through a short position in 20-year bonds through the iShares 20+ Year Treasury Bond ETF ( TLT ).

A closed-end fund activist (Saba Capital) bought a sizeable position and could lean on management to narrow the discount, or not use all this leverage if it doesn’t make money but does generate fees. In addition, the fund's top holding is Energy Harbor Corp, which is an illiquid equity investment that is being acquired in a complicated transaction with Vistra ( VST ). This transaction would free up much capital to engage in buybacks at a beautiful discount to net asset value. It is a utility transaction, and these can run into regulatory trouble. It could close, which would be a good thing. If it doesn’t close the fund needs to find another way to monetize this sizeable stake that doesn’t fit its mandate. The discount could be narrowed through activist pressure, Nuveen acting like a good steward of capital, and by simplifying the fund and investing a municipal bond fund into municipal bonds. Meanwhile, I'm collecting a small carry over treasuries while running a credit risk.

3. Flow Traders

Flow Traders Ltd. (FLTLF) is a trading firm that does much market making in ETPs. It is based and primarily traded in Amsterdam, which may explain why it is overlooked even though it has 500 employees and a market cap of $800 million at EUR 18 per share.

This is one of my long-term core holdings because the company's earnings expand greatly when the market is stressed. When volatility spikes, the spreads on ETPs widen, and market makers can make much more money. This is evidenced by the spike in revenue in Q1 2020. Flow traders pays a dividend 2x per year. In the last two years, it only paid about 50% of earnings EUR 1.35 and EUR 1.50. The year before that (Covid crisis), it paid out EUR 6.5, which represented only 65% of earnings. Over the years, it has been gradually growing its trading volume by taking market share in adjacent and new markets.

4. Pioneer Natural Resources

Exxon Mobil Corporation ( XOM ) is taking over Pioneer Natural Resources Company ( PXD ) in an all-stock transaction . PXD shareholders get 2.3234 shares of Exxon per share. I like this deal because there’s a decent spread of around ~$12.5 between the share price and the offer. In all stock deals, I can short the acquirer and go long the target, which ties up very little capital. The return is generated on very little capital. The additional risk of these transactions (over the usual M&A risks) is that the acquirer becomes a target. It is rare, but if it occurs, and causes the original deal to break, you lose on both sides. Because Exxon is a $400 billion+ company, it is improbable to occur.

5. Grayscale Bitcoin Trust

Even though I primarily bought the Grayscale Bitcoin Trust ( GBTC ) again, end of 2022, to capture the monster discount , I've also used it as a preferred way to obtain Bitcoin exposure. We're getting to a discount level where I've decided to get Bitcoin (BTC-USD) beta somewhere else (I wrote up one example here ) and use the Grayscale position only to capture the juicy arbitrage. I am bullish on Bitcoin and think the by-now much-publicized ETF tailwind and halving event are real tailwinds.

Conclusion

Before putting together this end-of-year list, I didn't realize it is a reasonable reflection of things that I usually work on. The most surprising to me is the T-bills allocation as it is more macro than special-situations oriented. However, I got interested in macro because I view it as another layer of risk control. When I ignored it my portfolio could get unbalanced to macro risks without me realizing it. If I'm just taking every good bottom-up bet I can find, sometimes these are available and all tied to some macro event(like low or high-interest rates).

Otherwise, there is M&A, which I've come to appreciate a lot for its predictable returns (while pulling my hair out over when value investing would come back in style).

There is crypto which is a new field with incredible volatility and rife with misinformation, fraud and on top of that is in the early stages of decent regulatory frameworks, which dissuaded institutional adoption. It sounds awful. And there is a lot of awfulness. However, that's also why I believe I can add some value by trawling through the stuff few other people are. Finding the stuff that isn't awful at all.

Long volatility is something I'm always looking for but reluctant to pay for. I rarely find it.

Finally, the top 5 includes closed-end fund arbitrage, which is another special situation that I like.

On my Investing Group, I've expanded the above to a top 10. If you like the ideas in the top-5 you will like the top-10 even more. Each investment is selected with an eye toward making my portfolio more resilient and predictably profitable.

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