Bitcoin as “frontier investing”

Markets scale new heights: what comes next?

Last time, we looked at the inevitable tradeoffs in how investors think about investing, especially when markets have been probing news highs amidst rising volatility (“Should you stay or should you go?” We suggested that two types of investors, volatility-focused and performance-focused, would look at this problem in different ways. We also considered that two types of investment would have a bearing: close-the-discount and compounders. This time, we want to look at what might come next. And what we’re looking at might come as a surprise.

Frontier investing and thoughts on Bitcoin

Pender’s investment slogan is “Forward thinking. Finding value.” We have benefitted from being forward thinking on digital acceleration starting this spring, and we have been giving more thought to what might come next.

One area we have been exploring lately is decentralized finance in general, and Bitcoin more specifically. Decentralized finance, commonly referred to as DeFi, is an experimental form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks, and instead utilizes smart contracts on blockchains. In many respects, we consider this fast-developing field as “Frontier Investing.” Most mainstream investors are still grappling to fully understand it (including us!), but it is quickly gathering momentum.

Bitcoin is a cryptocurrency invented in 2008 by an unknown person or group of people using the name Satoshi Nakamoto. It was implemented and released as open-source software in 2009. It has had a bumpy ride since then. But after battling many competitive alternatives, Bitcoin has emerged as the breakout leader of a new digital monetary network. It is by far the largest of the various competing peers by market cap. Some might even be tempted to say that it “won by a lot.”

This go-to status essentially makes it the “safest” crypto asset from an institutional point of view, which helps it attract larger capital pools, and which has led to a positive feedback loop, further cementing its leadership. Belief in Bitcoin appears to be in the process of moving from the early tech innovators (and frankly, sometimes the lunatic fringe) into the early majority. Numerous notable investors, regulators, corporations, and governments are increasingly taking Bitcoin seriously. When a growing wall of demand meets limited supply, interesting things can happen. It is an area we are taking seriously because of the disruptive impact it could have on several important industries.

A significant part of our interest comes from studying the unintended second and third order consequences of the unprecedented central bank and fiscal intervention effort to fight the economic slowdown from Covid-19. It remains a relatively early stage, controversial and divisive asset class, especially in the Western world, hence the “frontier” label.

Skeptics consider crypto assets as a mania-driven bubble of illusionary value. Some of the more recent bulls view it as a credible hedge against runaway central bank money printing. And many investors are starting to appreciate that in a world of no coupons, one needs to rethink opportunity cost. If the latter view is true, Bitcoin may be at the relatively early stages of growing into a significant asset class, akin to digital gold. What should an investor do when potential outcomes are binary?

When considering a non-consensus emerging asset like Bitcoin, we believe legendary investor Howard Marks best explained the problem: “Extraordinary performance comes only from correct non-consensus forecasts, but non-consensus forecasts are hard to make, hard to make correctly and hard to act on.”

We believe some exposure to Bitcoin makes sense because the payoff could be sizable. But we also want to avoid catastrophic risk. Our approach has been largely to initiate our initial exposure through low-risk optionality. Call it a “heads-I-win-a-lot, tails-I-don’t-lose-that-much” strategy. We have some modest indirect exposure across a few mandates. Some Pender holdings that are indirect beneficiaries of this trend include BIGG, MSTR, SQ, and FRMO. The good news is, as of this writing, these holdings are well above our initial purchase prices. The bad news is that these higher prices change the risk profile.

Nevertheless, we remain constructive as long as we see Bitcoin continuing to gain credibility and momentum. Time will tell whether the bulls or bears are right. Whatever happens, it won’t be a smooth journey. Once again, don’t be surprised if volatility continues to be the price that you need to pay for potential performance.

Felix Narhi, CFA, is Chief Investment Officer and Portfolio Manager at PenderFund Capital Management. He works alongside David Barr, Pender’s President, in setting the direction of Pender’s overall investment strategy. This article first appeared in the Pender blog. Used with permission.

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