Would You Pay $800 for an Asset Worth $432?
by Charles Rotblut | September 07, 2017
Under most circumstances, an investor offered an asset worth $432 would refuse to pay $800 for it. Such a premium is difficult to justify, especially for an asset with a transparent, easily determinable value. Yet when mania is mixed with other compounding factors, logic can be tossed out the window.
The Bitcoin Investment Trust (GBTC) is such an example. Speculators have let greed get in way of good old-fashioned facts. The absurd market price highlights the importance of paying attention to the net asset value (NAV) of an exchange-traded fund, a trust or a closed-end fund. It also reflects what can happen when obstacles to arbitrage may exist.
First, a bit of background. The Bitcoin Investment Trust trades like an exchange-traded fund. Shares are a beneficial interest in a grantor’s trust whose sole investment is the cryptocurrency bitcoin. Each share of the trust is equivalent to 0.093 bitcoins. Add in the annual sponsor’s (meaning management) fee of 2% and it’s easy to determine the price that shares of the trust should be trading at. (Various financial websites will automatically do the calculation for you.) As of last Friday’s close, the net asset value of each share of the trust was $432.33. The market price, meaning what investors were paying to own a share, was $800.
If investors were always as rational as a great deal of economic theory assumes them to be, this price disparity would not happen. There is simply no defensible reason for paying an 85% premium to own shares of a fund or a trust. Yet, investors obviously are doing so.
One reason why is the difficulty of directly holding bitcoin. Another is likely an inability to use arbitrage to take advantage of the price mismatch. A third is downright pure speculation and greed.
Bitcoin itself cannot be purchased or held in accounts with major brokers. At the same time, there may be difficulties to selling short shares of the trust. I say this because by short selling shares of the trust and buying (“going long”) the equivalent amount of bitcoin, an investor should be able to profit from a convergence in the prices of the two. A hurdle to such an arbitrage strategy beyond logistical matters is the risk of the market staying irrational longer than you can stay solvent.
Setting aside the arbitrage issue, there is still the issue of speculation and greed. In their desire to participate in the latest mania, investors are overlooking the basic facts. In the specific case of the Bitcoin Investment Trust, it’s the reality that the shares are trading for nearly double what the underlying asset is currently priced at. Buying shares at the current price is not only assuming that the value of bitcoin will continue to rise further, but also that somebody else will be willing to pay an excessive premium for your shares of the trust. That’s a risky bet, and certainly one I wouldn’t want any part of.
As some of you may have noticed, I’ve sidestepped discussing the value of bitcoin (which in itself is questionable). That’s purposeful, because I want the focus to be on why you should pay attention to a fund’s and a trust’s net asset value. Any mismatch between supply and demand for a fund does not alter the NAV. A share price above the NAV only occurs when someone has paid more than a dollar for a dollar’s worth of assets.
- ETFs and ETNs: Knowing What You Own – When a fund’s price diverges from its net asset value, the fund’s returns can differ from what an investor expects them to be.
- Shorting: A Strategy for Profiting From Price Declines – A co-manager of the Grizzly Short Fund (GRZZX) discusses some of the considerations short sellers have to take into consideration.
Pessimism among individual investors about the short-term direction of stock prices pulled back from its five-month high. The latest AAII Sentiment Survey also shows a rebound in optimism.
Bullish sentiment, expectations that stock prices will rise over the next six months, rose 4.3 percentage points to 29.3%. This is the 28th consecutive week and the 33rd time out of the last 34 weeks that bullish sentiment is below its historical average of 38.5%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined a by mere 0.1 percentage points to 35.0%. Neutral sentiment remains above its historical average of 31.0% for the 19th consecutive week and the 24th time out of the last 25 weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 4.2 percentage points to 35.7%. The drop follows what had been the second-highest reading of the year for pessimism. This is the sixth consecutive week with a bearish sentiment reading above its historical average of 30.5%.
Optimism rose from what had been an unusually low reading last week. At its current level, bullish sentiment is only back up to near the bottom of its typical range. Pessimism, conversely, receded from the top of its typical range.
Political drama in Washington, concerns about perceived high valuations and the possibility of a pullback are combining to dampen the short-term expectations for stock prices that are held by many individual investors. Some investors, however, are encouraged by continuing economic and earnings growth as well as the record highs set by the large-cap indexes this year.
This week’s special question asked AAII members what impact they expect this summer’s storms will have on the economy. Many of the respondents expect both a short-term negative impact from Harvey’s damage and a long-term positive impact from the rebuilding. Broken into overlapping groups, 43% of respondents expect economic growth to be hurt initially, while 38% expect growth to rebound over the longer term. An additional 22% think the storms will have limited or no impact.
Here is a sampling of the responses:
- “A drag for a brief period following the storms. Then a pickup in housing and materials.”
- “May hurt some insurers, but may actually increase the economy slightly due to the rebuilding process.”
- “Neutral impact. Most things will remain unchanged in the economy.”
- “An opportunity for energy companies to raise prices. Financial/insurance industry will take a hit.”
- “Little, if any long-term impact.”
Bullish: 29.3%, up 4.3 points
Neutral: 35.0%, down 0.1 points
Bearish: 35.7%, down 4.2 points
Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
August 31, 2017 Trades Are About to Settle a Day Sooner
August 24, 2017 What You Can Expect at the AAII Investor Conference
August 17, 2017 The New Bubble: Bitcoin and Other Cryptocurrencies
August 10, 2017 Value Investing Is Not Dead
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