science

BST: A Prime Panic Candidate – Seeking Alpha


Co-produced by Stanford Chemist

The BlackRock Science and Technology Trust (BST) is acting exactly as anticipated for these past few days of intense selling pressure. This tech-focused fund is not for those without a long-term view. However, with this intense selling pressure over the last few days can come an opportunity for those willing to withstand volatility. BST has now entered into discount territory. An area we have not witnessed since mid-2019 briefly. Before that, there hasn’t been an extended period of time since early 2018. From that point, since the fund’s inception, we were presented with a deep discount though, so that is worth noting.

It has been quite a while since we last covered BST. I believe now is a great time to get a refresher on this fund with the latest hits the market has been taking. In addition to picking up this name in a downturn to await its former highs – an investor gets to collect a distribution rate of 6.13%. Which grows increasingly higher the lower the share price, of course. In addition to this, BST just recently raised its distribution from the previous rate of $0.15 to $0.1655 per month. This is lower than many of the other funds that we typically focus on, but there is very real growth potential included in this name.

About The Fund

BST has an investment objective of “providing income and total return through a combination of current income, current gains and long-term capital appreciation.” They intend to achieve this objective by “invest at least 80% of its total assets in equity securities issued by U.S. and non-U.S. science and technology companies in any market capitalization range, selected for their rapid and sustainable growth potential from the development, advancement and use of science and/or technology (high growth science and technology stocks, and/or potential to generate current income from advantageous dividend yields.” In addition to this lengthy definition of their strategy, they will also “employ a strategy of writing covered call options on a portion of the common stocks in its portfolio.”

This will allow them to collect premiums from writing calls and potentially profit anyway the market moves. This is a slightly defensive posture in the fund. Although in the steepest selloffs, like the last few days, it isn’t nearly enough to offset the drop. Their targeted overwritten percentage is in the 30 to 40% range. This allows for a larger portion of the underlying portfolio to not be called away and potentially continue to appreciate. The latest percentage overwritten as of January 31st, 2020 was 32.08%.

It is also important to note that the fund mentions any market capitalization range, but they generally lean in favor of the larger cap names. These are household names like Microsoft (MSFT) and Apple (AAPL). These were last reported as their 1st and 2nd largest positions, respectively.

The fund has total managed assets of $760,896,007 and utilizes no leverage. The expense ratio for the fund is 1.09%. I believe this is a more than fair enough expense ratio.

Performance

The latest discount has appeared as shares ended the day on February 20th at $35.38 per share, with a NAV per share of $35.43. As of the close on February 25th, shares closed at $32.89 and NAV per share closed at $33.40. On March 24th, shares are down to $26.40 and a NAV per share of $27.87

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This is good for a wide discount of 5.27%, the steepest discount we have seen for the last couple of years. While I believe now is an excellent entry price, for those with a long-term outlook, I’m certainly not going to imply that I know exactly when the bottom is in.

From February 20th to February 26th (the 22nd and 23rd being a weekend) we can see the vast selloff in the broader market as well as BST. BST’s price performance comes right in line with the broader market. In this case, we are looking at the S&P 500 ETF (SPY) and the more closely related tech-focused ETF Technology Select Sector SPDR (XLK). The price-performance puts BST right in the middle of these two ETFs.

Chart

Data by YCharts

While I’m primarily focusing on the discount/premium levels in the fund, that’s not the main draw for BST, necessarily. A discount on a quality fund is a huge draw, as most CEF investors know. However, I believe this fund’s main draw is the overall market hitting volatility and causing the underlying tech positions to become quite attractive. That I believe is the real draw on BST.

This is in addition to the very competent BlackRock fund sponsor and the remarkable results that this fund has been able to achieve. Of course, this is thanks to its tech focus that has been working tremendously for the last several years. This is a play on the “growth” portion of the market and not necessarily the “value” stocks.

In fact, the fund has done exceptionally well since inception. Which is to be expected in the environment from its inception date of October 29th, 2014.

Chart

Data by YCharts

In fact, the latest drop on a YTD basis is not too terrible, relatively speaking with the broader market. The fact is BST’s NAV had a total return of over 38% for 2018. Meaning that we haven’t given up those gains just yet. You might also be interested in hearing that BST also recorded a positive total NAV return in 2018 of 0.23% – when many other funds were negative.

ChartData by YCharts

Distribution

As previously mentioned, BST recently just raised its distribution with its December payout. The distribution went from $0.15 to $0.1655 – a 10.3% increase. At the same time, they had announced that the fund also announced a long-term cap gain payout of $1.6852. In addition to all of that good news, this wasn’t the first time this fund has raised its distribution either. At inception, the fund started with an initial $0.10 monthly per-share amount.

(Source – CEFConnect)

That incredibly large year-end payout does make the above graph quite difficult to interpret, however, it is also nice seeing such a large payout at the same time!

As with many equity CEFs, a majority of the payout will come from capital gains realized on the underlying portfolio.

(Source – Semi-Annual Report)

And in fact, the fund doesn’t even report any NII as the expenses outweigh all cash from dividends and interest on the fund. With that being said, it is important that for tax purposes, the final tax characteristics can still be reported at ordinary income levels.

Which is exactly what we see for BST in 2017. They reported a “loss” on NII of $1,073,646 – but still managed to classify their final distribution as a small portion being attributed to ordinary income. Additionally, we can see that in 2017 the fund even had a return of capital portion for the majority of their total distribution for the year. This was even after the fund had performed incredibly for the year. This can be partially attributed to the fact that its written options strategy reported a loss of over $16 million for that year. This is in addition to the fact that the fund can turn unrealized losses into realized losses – all the while the fund still appreciates.

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This isn’t anything out of the ordinary though. Some investors that hold BST in a taxable account may even find this favorable as long-term capital gain rates are generally lower than their ordinary-income rate. The ROC portion of their past distribution can also be viewed in a favorable light for some investors. What ROC does when it is utilized in the tax breakdown is lower on an investor’s cost basis. This has the effect of deferring tax obligations until when an investor goes to sell the shares.

Holdings

(Source – Fund Website)

As previously mentioned, the fund is generally made up of larger market cap positions. In fact, they report that 71.97% of the fund is in positions with a market cap of $10 billion+. The average market cap overall of holdings comes in at $290,691.2 million. Which is no surprise when taking a look at their top holdings.

(Source – Fund Website)

These larger-cap positions, in theory, should provide a bit more stability when compared to smaller cap stocks. This can be represented by BlackRock Science and Technology Trust II (BSTZ). BSTZ has a portfolio with an average market cap of $18,187.8 million. Certainly much smaller in size relative to BST.

Chart

Data by YCharts

Although, when taking a look at the same performance period of the 5-days that we did above – they are very comparable. So, this theory isn’t proven in the scope of just these recent 5-days. There could be several contributing factors to this; for one, this may be too short of a downturn to truly get a good look, and for two, the fact that BSTZ has more of an emphasis on private investments. This can allow for the ‘true’ value of these positions not to be known until they look to divest them. At the same time, the fact that BlackRock is the largest asset manager in the world leads me to believe they can be fairly accurate in their valuations. Though I’m not sure how frequently the values are updated.

As of the latest report available – BSTZ had no level 3 securities at that time. Although, the report was for only a very short period of time after its inception. More specifically, the report was good for two trading days in total. Though they last reported in Q4 2019 that the fund had ratcheted up to a total of $120 million (8% of assets) in private investments. They ultimately are looking to invest up to 25% of their assets in private investments. In contrast, BST has about $14.8 million in level 3 securities.

For these reasons, that can help explain why our smaller-cap counterpart, BSTZ, isn’t showing even worse performance.

We can take a closer look at the performance of several of BST’s top positions though, for a deeper look at what is moving the fund over the past several days.

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Chart

Data by YCharts

These are the top five positions in BST – they represent a total of almost 18.5% of the fund’s total assets. Additionally, the total top ten makes up 31.29% of the fund.

Chart

Data by YCharts

It is quite interesting to note that Visa (V) and Mastercard (MA) are already in what would be correction territory. A drop of 10% or more, in just five days. Although, the technical term refers to a position that drops 10% or more from its peak – which isn’t reflected in this chart. I will go out on a limb here though and say that it may be close, based purely on the fact that the broader market was hitting an all-time high just last week. Additionally, MSFT and AAPL are close to correction territory as well. We could easily see them or any of the other names on the list hit correction levels too with little downward movement.

Conclusion

BST is an aggressive tech-focused holding that may be presenting a buying opportunity – now or soon. The latest volatility in the market could be presenting an opportunity for an investor that has a long-term view in mind. I certainly don’t claim to know when a bottom would be in the stock or the overall market – but I do know that I would be willing to pick up shares in the name should we see a little further selling.

If we get another couple more days of selling off, BST could become even more discounted to its NAV than already is available. Which would indeed make it just that much more attractive. Although, I believe the major draw on the fund is the fact that you can get a very healthy distribution rate relative to holding these tech names outright. In fact, several of these names don’t even provide any dividend at all for shareholders.

With that in mind, we should expect almost all of their distribution to be composed of capital gains or return of capital. This may prove favorable if an investor is holding this name in a taxable account. The lower tax obligations compared to ordinary income rates can be quite attractive.

I want to stress it one last time, this fund would be for someone looking to hold over a long-term time horizon. This is not a position for an investor that cannot handle volatility. However, if you are an aggressive investor – then this one is for you!

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Disclosure: I am/we are long BST, BSTZ, MSFT, MA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was originally published on February 26th, 2020 to members of the CEF/ETF Income Laboratory.





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