STK: Tech Fund Missed Out On The Recent Rally, Underperformance To Continue

Summary

• STK invests in tech stocks while employing a call-selling strategy to generate income.
• The fund has underperformed its sector benchmark this year considering the extreme market volatility and specific portfolio exposure.
• The combination of an unimpressive returns history, a wide premium to NAV, and our cautious outlook on the market keeps us from recommending this fund.
• Looking for a portfolio of ideas like this one? Members of Core-Satellite Dossier get exclusive access to our model portfolio. Get started today »

The Columbia Seligman Premium Tech Growth Fund (NYSE:STK) is a closed-end fund (CEF) that invests in technology sector stocks. The fund utilizes an options selling strategy that supports its managed distribution policy that currently yields 9.2%, making STK an interesting vehicle for income-focused investors. That being said, we highlight a relatively poor performance history with the fund lagging its benchmark this year, potentially exposing some weaknesses in the strategy and the portfolio allocation. We recommend investors avoid STK in the context of our overall cautious market outlook as risks are tilted to the downside.

(Source: finviz.com)

STK Strategy Background

STK is actively managed, meaning the portfolio holdings are not meant to track any particular index. The strategy focuses on growth tech stocks and uses the NASDAQ-100 (QQQ) to employ a rules-based call option writing strategy. By selling calls on the index, the fund collects the options' premium which generates income and also represents a partial hedge against a market move lower. All else equal, a call writing strategy will tend to underperform in a strong bull market while it should limit losses on the way down.

STK adjusts the level of call selling and coverage ratio following the volatility level of NASDAQ-100 based on the 'VXN Index.' In an environment of low volatility with the VXN Index at a level of 17 or lower, the aggregate notional amount of written call options as a percentage of the fund's equity holdings is kept at 25%. At higher VXN index levels, the fund's rules dictate increased call selling up to 90% of the stock exposure value.

(Source: Columbia Seligman)

This is important considering the NASDAQ-100 this year experienced extreme levels of volatility with the VXN index reaching a high of 80 in March. Indeed, with official fund data through March 31^st, STK had 89.9% of the fund's value covered with the "over-write" strategy.

Data by

YCharts

Essentially, the fund takes a more defensive position as volatility rises. The problem, however, is that extreme levels of volatility like what was observed in March oftentimes point to key market reversals. STK was selling calls at least through the end of March, precisely at the time when buying calls or being unhedged to the upside would have been optimal. Since NASDAQ-100 rallied 15% in April, the large call-write position detracted from the fund's performance over the month by limiting upside.

Based on the current VXN level of 36 which has trended lower in recent weeks, STK's rules-based option strategy dictates that it may still have 90% of the aggregate notional values of fund's common stocks hedged with covered calls. This implies the fund is not participating completely during the current rally in tech stocks.

STK Holdings

The fund's portfolio holdings are based on the fund manager's market outlook and expectations. STK's largest position as of March 31^st was in Lam Research (LRCX) with an 8% weighting. This stock is down 15% year to date and has also dragged the fund's total return this year. Notably, STK is underweight several of the top holdings of QQQ like Microsoft (MSFT), Apple (AAPL) which together represent about 10% of the fund compared to about 23% of QQQ.

(Source: Columbia Seligman)

Separately, STK does not hold shares in Amazon.com, Inc. (AMZN) which has a 10% weighting in QQQ and has been a strong performer, up 26% year to date. These dynamics help explain the underperformance of STK this year against the NASDAQ-100 benchmark. STK is down by 12.3% compared to a 2.9% gain in QQQ in 2020.

Data by YCharts

STK Performance

We note that STK has had an underwhelming performance history over the past decade on a total return basis to the market price and NAV. We compared the returns for the fund to two-alternate "covered-call"/ overwrite NASDAQ-100 funds and found that STK has been a laggard this year. Year to date, STK is down 14.1% compared to a 2.5% gain in QQQ, an 8% decline in theNuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX) and a 12% loss from the Global X NASDAQ 100 Covered Call ETF (QYLD).

(Source: data by YCharts/table by author)

QQQX is also a CEF but is meant to offer more passive exposure to the index while employing a "dynamic" covered call strategy depending on the portfolio manager's market view. QYLD as an ETF also provides passive exposure to the NASDAQ-100 stocks but maintains a near 100% covered call ratio consistent with the tracking 'CBOE NASDAQ-100 BuyWrite Index.' We are also including the BlackRock Science and Technology Trust (BST) as a comparable CEF for tech sector equity exposure. This fund also invests in healthcare sector stocks but is included here reference purposes as it has been a top performer among equity-CEFs.

STK has underperformed QQQ, QQQX, and BST over the past couple of years. In a 3-year lookback period, QQQ has gained 63% compared to 21% for STK, 24% for QQQX, 86% for BST, and 15.7% for QYLD.

Another disappointment for STK is that the fund management specifically mentions the call-writing strategy as designed to "mitigate downside volatility."

(Source: Seligman Threadneedle)

Shareholders that may have expected the fund to represent a defensive position in the market were in for a surprise when STK presented a drawdown of 40.74% this year at the market low on March 23^rd. This compares to QQQ which had a drawdown of 27.9%, while only QYLD ETF in the group was able to provide some downside protection with a slightly lower 23.96% decline.

Data by YCharts

Wide Premium To NAV

The other consideration here is that STK is currently trading at a historically wide premium to NAV of 9.6%. While the fund has briefly traded at higher premiums over the past decade, the average spread to its net asset value has averaged 2.9% in the past five years. This implies that the fund is expensive as investors have typically been able to acquire shares closer to the underlying value of the portfolio holdings.

Data by YCharts

It's also a significantly wider spread compared to QQQX at 0.98% and QYLD at just 0.2%. Oftentimes, a higher premium in a CEF can be explained as investors paying up to be invested alongside a star fund manager or if the strategy is performing well; we don't think that's the case here.

Our point is that it simply adds to one more reason why we are avoiding STK at the current level. Investors interested in STK should wait for an opportunity to pick up shares when and if the fund trades at a discount to NAV. A narrowing of the premium from current levels would drive an incremental loss for shareholders at the market price.

Distribution Yield

One of the positive aspects of the fund is that it has been able to distribute its quarterly distribution without the use of return of capital payments, also known as "ROC." The payments have been facilitated by the strong market performance which has supported the NAV of the fund during the bull market in tech stocks in recent years. Since 2014, all distributions have been covered through the regular capital gains of the fund's trading activity. Considering the fund's NAV is down 23% year to date in 2020, it becomes increasingly possible that ROC could be necessary later this year.

(Source: Seligman Threadneedle)

Going back to our comparison of STK with comparable funds, the distribution yield of 9.2% is above QQQX's 7.1%, but below QYLD which yields 11.7% as the two alternate "options strategy tech CEFs." Recognizing that each fund features a different strategy, QQQX and QYLD more regularly utilize return of capital payments. BST's 10.7% yield includes a smaller quarterly distribution and a special distribution paid in Q4 of 2019 and 2018. The stated yield on BST's regular distribution is 5.7% and the fund pays monthly.

Data by YCharts

Analysis and Forward-Looking Commentary

The market rally since the end of March particularly in tech stocks has been impressive. Despite the ongoing coronavirus pandemic and looming worldwide recession, investors are focusing more on the enormous relief efforts between the Fed and government that are expected to support a recovery process. Technology companies are seen as more resilient, considering trends in stay and work from home accelerating a transition to the digital economy.

On the other hand, our concern comes down to valuation as many of the sector leaders are back to trading near all-time highs. The biggest risk we see is the potential for structurally higher unemployment through 2021 pressuring consumer spending and growth trends for tech stocks. We sense that the market is already expensive and is pricing in exuberant best-case-scenarios while the risks are tilted to the downside. Renewed volatility and another leg lower in the stock market can be bearish for tech and the STK fund.

To summarize, the following points keep us away from STK.

• Regular underperformance to the tech sector benchmark.
• Unconvincing stock picking ability by management team considering a large position in Lam Research significantly detracted from performance this year and the fund did not hold Amzon.com which has been a big winner.
• Currently wide premium to NAV suggesting the fund is relatively expensive.
• We think QQQX and BST are better alternatives.
• An overall bearish outlook on the market from current levels considering sharp rally since March lows while risks remain tilted to the downside.

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.

Comments

[WSLegend]

Only valid point here is about the Premium!
Never buy a CEF at a premium.

[Dan Victor, CFA]

premium 5/12 has reached 12.6%.. unjustified IMO.. I'm sure shareholders are happy but a selloff in the tech sector can lead to large losses here.. high risk here

[AnthonyGiordano]

Thanks for the article, it was pertinent to me because I recently made an initial purchase at the end of April at about $ 19. I would like to hold this fund long term and continue to DRIP in as well as buy on dips. I bought it and look forward to holding some diversified tech names compared to my standard held tech names, understanding that I won't get the growth of non-covered call tech funds, but I'm giving some of that up to get the income this throws off so steadily.

[battered]

Well, you get kudos from me .. After reading your article, and doing some comparisons of my own, it is clear that the Q's blow STK away .. I'm not an income at any cost kind of person, and don;t see a fit in my portfolio. I don;t have the data or the inclination, but it seems to me that if you had invested in QQQ and took your 8 or 9 per cent drawdown every year to "compensate" for the STK distribution, you;d still be money ahead, and not have to worry about the NAV premium or hedging risks .. But that's me .. Thank you

[Hank890]

I buy STK when a scare runs through the market, and then hold to collect the distributions---until the price gets too frothy. Since 2016 there has been a chance to lock in profit about every 14-16 months.

For example, at the very end of 2018 and in March 2020 the price dropped enough to make STK a bargain acquisition. The cap gain on the shares purchased 6 weeks ago have had a 34% gain--in 6 weeks. Plus, the fund pays monthly distributions,... of 8+% annually.

if the fund gets back to or above 23, I'll trim back the holding again. But I do not go void. I like the distribution too much.

The trick with STK is to purchase ONLY it when there is fear loose in the market, i.e. when the price is under 15. Then DRIP at prices under 18, and trim back the holding at prices over 23 and change. Right now, at 20 and change, STK is not really a bargain. Wait for an attractive entry point.

Both Amazon and FB have continuing chronic political legal anti-trust problems. Semis are quite cyclical, but on an up turn at the moment. Ad supported social media of all kinds have entered a period of lower ad demand. The STK technology portfolio is diverse, and good quality, but LAM was the rare disappointment. LAM is the reason that STK is trading at a premium over NAV at the moment.

[User 50688535]

stk pays quarterly. But I agree w/your comment.

[Park1000]

Not a well reasoned article. No need to trash $STK. Many of us here hold Index etfs ($spy $qqq) for long term capital appreciation and CEFs for income.. As long as $STK pays the yield without destroying NAV, most are fine with it.

[sc21]

STK has been a fairly steady payer and is primarily an income source not a source for growth. While the NAV has actually increased over time, what is core is the payout. BST is a very well managed firm. If you want to own bst, which I do, then do so but no need to drop on STK. These two firms are very close in terms of investment style.Overall BST has delivered a slightly higher total return but normally has slightly lower payouts. sc

[adam22164]

Have to disagree with you on this one. STK is and will continue to be a core holding in my income portfolio. The long term performance has been fantastic and the fund's distribution has been entirely of Long Term Capital Gains for quite some time. This tells me they are consistently making money based on appreciation of their holdings with no ROC. There are so many crappy CEF's to write about, STK is simply not one of them. Try writing about the levered MLP funds, now there is some crap....

[SayItWithLyrics]

I've owned STK since 2014. That 5 year return on your chart is pretty impressive.

My total portfolio is overweight tech and has been for years. I have lots of VGT (LT gains, very low div), lots of STK (gains largely paid out as distributions), and a bunch of individual tech stocks (AAPL, Amazon, etc). I trade in and out of various holdings with about 15% of my tech allocation, holding the other 85% long-term.

STK has done extremely well by me, as your 5 year return number shows. I see no reason to jump to another option for that portion of my holdings.

STK is a bit pricey at this moment with it's 9% premium to NAV, so this probably isn't a good day to be buying. But I take that as market confidence in the fund. I think the normal gap to NAV is around a 2% premium, also an indicator of market confidence.

[Real-Time Retired Guy]

Considering BOOX' past performance, I think STK is a safe hold.

[adam22164]

@Real-Time Retired Guy, couldn't agree with you more. Of all the terrible money-losing CEF's out there, BOOX writes about STK, a fund that has been nothing but a money making machine...

[Dan Victor, CFA]

this article is meant to explain why STK has underperformed this year. the NAV is down 24% this year while QQQ is down 8%. Ive been following this fund since it was a big winner in 2019. At this point, I believe BST is a better fund overall.

[adam22164]

@BOOX Research Then I'm glad I own both STK and BST, at least you like one of them :)

[User 50077887]

I hold STK for the diversification in tech compared to my other tech focused CEF’s. You make some nice arguments against the fund but I’ve owned it for a few years and plan to hold for the income. I’m not swayed.

[Dan Victor, CFA]

@movetohawaii thanks for the comment. the purpose here is to provide some coverage and keep the discussion going. i believe there is room for all types of stocks and funds including CEFs in the context of a diversified portfolio. good luck

[chris.strickland]

I first bought STK in Oct 2018, right now it's in the green, and paying a nice quarterly dividend. I was out of cash so I couldn't buy anymore in the 14's, but still I am up 4.31% as of this morning and I have been getting a YOC of 9.6% since I first bought. I wish all my stocks had performed this well. I'm looking for income more than growth at this point.

[chronicstocks]

Thank you for this article... been in this for over 5 years...appreciate your dive into some of the shortcomings and a very likely explanation of the "weak bounce".
My observations; STK moves in in lockstep with AAPl
It moves more than some of the peers in the covered call space many of
which lag the QQQ depressingly
your never going to get the performance of the QQQ or a good non covered
call fund;that's not what it s for.its for folks who want the extra income and will
trade some of the upside.
I need capital gains distributions; this has them .Its ridiculous to pay tax on dividends if you have a loss carry.Im sure all the experts never lose money so they don't need to work off a carry ...but maybe a COVID Loss?.
I have found only a handful of securities that pay in capital gains ;Im in QQQX SPYX DIAX QYLD
for this reason If Boxx research or any readers have any good prospects.. would sure love to hear of them.
thanks again for the great read !

[Patrick3]

Chronic - I have similar loss carry forwards. What have you found to be the better CEFs (beyond the 4 you mentioned) for tax sheltering cap gains?

[Fast Track to Financial Independence]

A lot of STK's underperformance is linked to the absence of the largest tech companies, but its focus on quality second-tier tech firms offers exposure to an interesting range of lesser-known assets. Investors have easy access to the household tech names via many funds, but STK can broaden their holdings quite nicely. STK management might want to consider lowering the cap on call writing.

[ChrisBe]

I very much agree with your thoughts, and doubt that the huge run up in big tech of the last 5 years will be repeated. Stk missed it but I stay long, also diversification

[SayItWithLyrics]

@ChrisBe

"STK missed it"???

Up 80% in 5 years is missing it?

QQQ was up 105%, so it came up a little short, but that is the expected price to pay for a distribution instrument v an investment accumulator.

Missed it? That's almost funny.

[ksal55]

BST pays monthly, currently holds 89 stocks and is apx 30% overwritten with call options.

[Oil Can]

Come back when you get the yield for $BST correct. One large special distribution doesn't make their yield almost 11%. And these days, we all know what 'special' distribution means - it means you likely won't get it.

Meanwhile, $STK has delivered a steady yield for more than 10 years now.

Long $STK.

[rickevantodd]

Good article. According to CEFConnect, the BST distribution rate is 6%. Where did your much higher yield info come from ? Also, you may not be showing a fair comparison since only 58% of the BST holdings are U.S. Thank you.

[Dan Victor, CFA]

you're right BST's regular monthly distribution currently set at $0.1655 yields about 6%. The yield in the chart in the article is including a $1.85 "special" distribution from December last year, they also paid in 2018. i updated the comment in the article for clarity.

[Prashant P]

Very good analysis. It’s a terrible fund

[alpine]

@BOOX Research
Most timely report, as I too have been spending lots of time researching these very names, along with a safe(r) CEF, ADX. For a retiree, it would seem ADX is a good, well tested CEF, esp. since its holdings cover many other areas that could "strive and survive" the touch economic and social times ahead. Of note, they have deftfully avoided high risk sectors like energy, airlines and hotels even if I wish they held less of banks.
I found STK a little "weird", as they have LRCX, but not ASML, and lots of AVGO, but not QCOM, V but not SQ or PYPL.
Finally, for a fund of their size, would it not be better if they either had a larger number of holdings allowing for their high 43% portfolio turnover, or, my preference, same number of better "core" names, with a much smaller portfoilio turnover. As example, BST has 32% turnover over 117 stocks (ok, they have a much bigger AUM).
Thank you sincerely for this report, I keep looking for a "perfect world" CEF that covers technology, but also biotech and pharma, but I cannot find one (save ADX). Any thoughts?