Pairs Trading Between BTA and VGM: A Comparative Analysis of Undervalued and Overvalued Positions

The article discusses pairs trading between BTA and VGM, comparing undervalued and overvalued positions. The author notes that BTA has a market capitalization of $16.3 billion and a forward P/E ratio of 9.5, while VGM has a market capitalization of $12.1 billion and a forward P/E ratio of 10.1. The author recommends a short position in BTA and a long position in VGM.

In the realm of pairs trading, the strategic focus is on the relative performance of two similar assets rather than their absolute direction. This approach offers a market-neutral strategy that can be particularly beneficial in volatile markets. Two closed-end funds, BlackRock Long-Term Municipal Advantage Trust (NYSE: BTA) and Invesco Trust for Investment Grade Municipals (NYSE: VGM), present an intriguing opportunity for pairs trading.

BTA Overview

BlackRock Long-Term Municipal Advantage Trust (BTA) is a closed-end fund with a market capitalization of approximately $16.3 billion and a forward P/E ratio of 9.5. The fund holds around $130 million in assets and has 13,439,892 shares outstanding. BTA's effective duration of approximately 15.54 years makes it sensitive to interest rate changes, which can be advantageous for investors expecting stability or a decline in interest rates. Currently, BTA is trading at a 6.05% discount, with a 1-year z-score of -0.74, indicating a significant underpricing relative to its historical values [1].

VGM Overview

Invesco Trust for Investment Grade Municipals (VGM) has a market capitalization of around $12.1 billion and a forward P/E ratio of 10.1. This fund has a current market capitalization of $514 million and 54 million shares outstanding, with total assets close to $864 million. VGM's option-adjusted duration is 9.67 years, and its weighted average maturity is 21.08 years. Although VGM is also trading at a discount of about 5%, its 1-year z-score is positive at 2.36, suggesting that its price is above the mean deviation and may be overvalued [1].

Pairs Trading Strategy

The primary idea behind pairs trading is to exploit temporary inefficiencies in the relative pricing of similar assets. In this case, the strategy involves taking a long position in VGM and a short position in BTA. The rationale behind this is that BTA is significantly undervalued, as indicated by its negative 1-year z-score, while VGM, despite trading at a discount, appears to be overvalued due to its positive z-score.

Risks and Considerations

While pairs trading can offer substantial returns, it is not without risks. The strategy relies on the assumption that the prices of the two funds will revert to their historical ratio. However, this assumption may not always hold true, leading to potential losses. Additionally, the structural differences between the funds, such as portfolio composition and sensitivity to interest rate changes, can result in a divergence rather than a mere temporary deviation. Monitoring the market and managing transaction costs are also crucial considerations for this strategy.

Conclusion

The proposed pairs trading idea between BTA and VGM is based on the differences in their current market valuations and statistical indicators. BTA's significant underpricing and VGM's potential overvaluation create a market-neutral opportunity. Investors should approach this strategy with a careful understanding of the specific characteristics of each asset and the potential risks involved.

References

[1] https://seekingalpha.com/article/4801427-pairs-trading-between-bta-and-vgm-comparison-of-undervalued-and-overvalued-positions