- The BlackRock Science and Technology Trust is an actively managed closed-end fund that employs a covered-call strategy to enhance returns.
- The fund pays a monthly distribution that yields 6.0%, including a recent hike to the regular rate last December.
- The fund is a good option among CEFs to gain exposure to tech stocks through a strong performing income vehicle.
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The BlackRock Science and Technology Trust (NYSE:NYSE:BST) with $720 million in assets under management is an equity closed-end fund 'CEF.' As the name implies, the company invests in both U.S. and non-U.S. science and tech stocks while also employing a call-writing options strategy as part of its active portfolio management. Impressively, the fund has been able to outperform the NASDAQ-100 since the fund's inception in 2014 on a total return basis. BST is also an attractive income vehicle as it currently yields 6% with a monthly distribution of long-term capital gains. With an overall favorable view of the strategy and fund structure, we think BST is a solid choice among CEFs for targeted tech exposure.
As an actively managed fund, BST is not constrained by any particular benchmark. As mentioned, the fund employs the use of covered calls or options selling on the underlying equity holdings. The purpose is to both generate recurring income and enhance returns as a form of risk management. The fund does not utilize leverage.
The current coverage ratio which reflects the relative amount of the portfolio for which the holdings have been covered by written call options is 32%. By this measure, the strategy as implemented is only a partial hedge on the performance compared to other funds with a more defined buy-write or covered-call strategy and coverage ratio that can approach 100%. The overall function of the options strategy is that it adds to the flexibility for the management team to take tactical positions in the options depending on market conditions. An example would be to sell calls on a position they believe to be overvalued or as a price target to realize gains.
In terms of the underlying holdings, a reasonable comparable for BST is the 'NASDAQ-100 ETF' Invesco QQQ (QQQ) as both funds feature many of the same underlying mega-cap tech holdings although we note several key differences. Fundamentally, BST includes stocks that are not listed on NASDAQ and features more global stocks.
(Source: YCharts/annotation by author)
Alibaba Group Holding Ltd. (BABA), the second-largest holding in BST with a 3.6% weighting, for example, is not included in QQQ. Other notable BST holdings that are not NASDAQ-100 stocks include Tencent Holdings Ltd. (OTCPK:TCEHY), and Shopify Inc. (SHOP), among others. By this measure, we like the diversification and wider exposure of the investment mandate compared to the passive QQQ strategy. BST holdings are based on the portfolio managers' market expectations.
BST holdings are less "top-heavy" compared to QQQ. For reference, the largest holding in BST is Microsoft Corp. (MSFT) with a 5% weighting, while QQQ features both Apple Inc. (AAPL) and MSFT each representing 11%. The top 10 holdings in BST represent 31% of the fund compared to 54% of QQQ. BST is effectively underweighting the top holdings from QQQ.
In terms of exposure at the sector level, keep in mind some of these classifications have a grey area. For example, it can be argued that Amazon.com, Inc. (AMZN) is both a tech stock and also part of the consumer cyclical 'discretionary' sector. Nevertheless, compared to QQQ, BST is overweight the "tech" sector which represents 59.4% of the fund and 44% in QQQ. BST is also overweight financial services with an 8.4% weighting compared to 1.8% in QQQ. Mastercard (MA) and Visa Inc. (V) within the top 10 holdings of BST are not constituents of QQQ.
(Source: YCharts/annotation by author)
The actual fund's performance benchmark is the 'MSCI ACWI Information Tech Call Overwrite Index.' In 2019, at the NAV level, BST returned 37.8% compared to 40.3% for the index. Keep in mind that BST is not meant to track any index. The MSCI Call Overwrite Index is used only as a reference point for its returns.
Since the index is not investable and there is no corresponding exchange-traded product to track the performance, we continue with our comparison to the more widely held QQQ fund for large-cap tech stock exposure.
With an inception date of October 2014, BST has benefited from the strong bull market and momentum in the technology sector. The fund is up 138.5% on a total return basis compared to 127.3% for QQQ over the period. The excess return of BST is even more evident over a five-year lookback period with BST returning 156.5% compared to 105.3% for QQQ, a nearly 5000 basis point advantage. On the other hand, BST has underperformed QQQ more recently including its more modest 12% return over the past year compared to QQQ which is still up 23.3% despite the recent market volatility.
(Source: data by YCharts/table by author)
The performance of QQQ in 2019 was supported by strong gains in its two largest holdings - Apple and Microsoft, with each up 89% and 58% for the year, respectively - which BST essentially underweights. The point here is not to suggest one fund is "better" or worse than another simply based on the performance, but to help explain how and why each has led in different time frames.
BST's market price return, as a closed-end fund, is also dependent on the volatility of its spread to NAV. The fund currently trades at parity to NAV but from the chart below we highlight the large swing from a discount of nearly 16% in early 2016 to a premium high near 13% in 2018. This tightening drove much of the outperformance to QQQ over the period. The current parity to NAV shows that the market price performance since inception is approximately consistent with the NAV total return.
This past December, BST hiked its regular monthly distribution rate by 10.3% to $0.1655 from the old $0.15 rate. Consistent with the strong performance of the market and fund in recent years, it's likely the new rate is sustainable based on the fund's underlying coverage. The current distribution rate annualized to $1.99 per share represents a 6% distribution yield. Notably, the entire distribution is funded from realized long-term capital gains. The fund historically has not regularly used return-of-capital (ROC) payouts.
Analysis and Forward-Looking Commentary
We balance our overall positive opinion of the fund and its structure with a more cautious outlook on equities and tech stocks for 2020. The ongoing coronavirus outbreak has resulted in historical levels of market volatility and continued uncertainty. Beyond the public health crisis that has spread to various regions of the world, we expect significant economic disruptions affecting corporate growth and earnings for the rest of 2020. Should conditions deteriorate from current expectations, we expect more downside for tech sector stocks and equities in general that are exposed to cyclical trends.
As it relates to BST, we are keeping this one on our radar and watching the spread to NAV as potentially signaling a compelling buying opportunity. Considering the average discount to NAV over the past 5 years has been -4%, we'd like to see the fund trade below that level before adding to shares.
BST is a good option among closed-end funds to gain exposure to large-cap tech stocks in a relatively diversified portfolio. We showed that the fund has favorably been able to outperform the widely followed NASDAQ-100 Index since inception and the higher yield makes it an interesting income vehicle. We recommend investors take the cash option on the distribution as a defensive approach with the potential of reinvesting the proceeds in the future at a more attractive level.
The fund's expense ratio at 1.0% is higher than comparable passively indexed ETFs, but in this case, the unique characteristics may make the premium worth it. We take a neutral view on the fund's near-term direction with a "hold" rating in the context of a more cautious outlook for equities in general in 2020. Take a look at the fund's annual report for a full list of risks and disclosures.
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This article was written by
Dan Victor, CFA is a market professional with more than 15 years of investment management experience across major financial institutions in research, strategy, and trading roles. Dan is the president of Posto Asset Management - a startup investment advisory firm based in Miami Beach, Florida.Dan leads the investing group Learn more
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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