- NBXG launched at a poor time for the growth-oriented investments that they target.
- The poor results and the fund being new have contributed to a significantly wide discount.
- The fund's distribution would seem to be at risk, barring any sharp snapback.
- This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on August 31, 2022.
Neuberger Berman Next Generation Connectivity Fund (NYSE:NBXG) shares similarities with BlackRock Innovation & Growth Trust (BIGZ) and BlackRock Science and Technology Trust II (BSTZ). NBXG and BIGZ had launched at what would turn out to be incredibly poor timing. BIGZ made it to the market in March 2021, and NBXG was hot on its heels, launching in May 2021. BSTZ's timing was quite a bit better, but the latest fate has been the same.
While there was high demand for these funds as they raised billions - a significantly large sum for closed-end funds - it turned out to probably be a mistake for BIGZ and NBXG. Both of these funds have performed incredibly poorly as growth took a nosedive shortly after they launched.
All three funds invest primarily in the growthiest of the growth stocks. This isn't just the mega-cap tech names of Apple (AAPL) or Microsoft (MSFT), names that have predictable and strong cash flows.
NBXG has been able to hold up materially better than BIGZ since the fund launched.
One of the factors contributing to this impact is the size of the underlying holdings. They share some overlap, but the average market cap for the underlying holding for BIGZ comes to $10,164 million. For NBXG, the average market cap of the underlying holding is $79,358 million.
On that metric, it would make the fund's portfolio closer to BSTZ, with its average market cap of underlying holding coming in at $70.335. NBXG has also outperformed BSTZ by a sizeable amount since it launched. Though the total share price return had been a bit closer.
I view NBXG as a mixture between BSTZ and BIGZ because they aren't necessarily focused entirely on tech. They are focused on more growth-oriented positions, including exposure outside the tech space. However, the majority of the portfolio is squarely in the tech sector.
At this time, all three of these funds carry significant discounts for what are rather interesting names in their top holdings. That being said, NBXG, BSTZ and BIGZ are both higher-risk funds, which would only be most appropriate for more speculative positions. If you have some speculative dollars and a long-term investing horizon, picking up a position at these levels could provide some upside.
- 1-Year Z-score: -0.75
- Discount: -16.86%
- Distribution Yield: 11.16%
- Expense Ratio: 1.30%
- Leverage: N/A
- Managed Assets: $970 million
- Structure: Term (anticipated liquidation date of May 26th, 2033)
NBXG is a "non-diversified, limited-term closed-end management investment company focused on next-generation mobile network connectivity and technology." They have no focus on U.S. or non-U.S. companies - instead, they are investing where they see fit. This also includes any market cap and private holdings.
Although, they do limit themselves to mostly equity investments. Given the volatility of equity positions in the field that they are investing in, it makes sense that they also don't intend to utilize any leverage. When interest rates rise, that is one less thing to worry about with this fund. With other CEFs that are leveraged, the borrowing costs on most funds will go up when interest rates rise.
The term structure means they anticipate liquidating in 2033. They include the standard tender offer at the end of the term to potentially switch to a perpetual fund. That is an offering for 100% of shares outstanding at 100% of NAV. If at least $200 million in net assets remain, the Board can decide to get rid of the term structure and change to perpetual. Given the fund's size, there is a good chance this could happen. However, if performance doesn't pick up, they might not want to switch to a perpetual structure.
Performance - Deep Discount
As we saw above, since the fund's launch, it has been a rather sharp downward trend. The distributions have done little to be able to offset the fund's price decline. However, the price decline has been at a much quicker downward slope than its NAV price. That results in the opportunity of a widening discount that we often look for in CEFs.
When a CEF launches, it generally tends to go to a discount rather quickly. The poor performance of the fund had likely accelerated that downward trend. Once investors saw that the Fed would raise rates, growth investments sank sharply. They have continued to be pressured as the Fed has stepped up the pace with more aggressive rate hikes than they originally thought necessary.
With the continued pressure, the underlying holdings have continued to become cheaper. Although still relatively more expensive than other sectors. They actually provide the statistics of valuation metrics on their underlying portfolio, which is incredibly helpful. I'll discuss more on that when talking about their portfolio.
I believe the current discount seems closer to what we can expect as a low. Despite all the volatility, the fund has been bumping around at this general level. That would suggest that losses due to further discount widening from here could be limited. Combining that with the portfolio valuation coming down, the future could be a bit brighter than the ~40% losses we have seen so far.
Distribution - Elevated Distribution Rate
They launched with a monthly $0.10 and have continued to pay that amount since then. The fund's distribution yield came to 11.16%. Thanks to the wide discount, the NAV rate comes to 9.28%. However, I suspect that is too high and not likely to be sustainable.
Being an equity fund, they will require capital gains to fund their distribution. In fact, being a growth-oriented fund, we see that not only will it require capital gains to fund its distribution, but it is entirely relied on to fund its distribution. The fund produces no net investment income.
That isn't uncommon and is the same thing we see in BIGZ and NBXG. It comes in negative because the dividends that the underlying positions payout are minimal. The expenses of the fund then get subtracted from the total investment income, and the ending figure is the NII.
As we can see, they have only realized unrealized losses for the first half of their fiscal year. The unrealized depreciation isn't too surprising. Since that report, depreciation would have only increased further. That doesn't mean that some underlying holdings couldn't have gains that they could realize. It just becomes increasingly more difficult to find in a bear market.
For tax purposes, unsurprisingly, we see the majority of the distribution as return of capital. I would also suspect that would be the classification for most of this year's payout. In this case, it is destructive ROC being used, which would be another reason why the fund should cut its distribution to save the remaining assets.
As I mentioned above, the fund holdings have come down in valuation significantly. Not only can we simply look at the price of the holdings and figure that out, but the statistics they provide. It's certainly a nice touch, and I'm glad they provide these metrics.
The portfolio held 70 positions in total. That's actually an increase from the 55 positions held previously. That's still a fairly narrowly focused fund, relatively speaking. The average market cap has also fallen from the nearly $105 million it had previously.
For the forward P/E, we can see that this has come down sharply from the 47x level it had previously. YCharts puts the S&P 500 forward P/E ratio at 16.95x. At the same time, the portfolio's estimated 3-5 year EPS growth comes in at ~25%. That's up from 21.45%. Of course, that would have an impact on reducing the forward P/E if they anticipate the 'E' part to grow faster.
The P/E to growth ratio has come down from 2.2x, and the P/S has come down from 8.7x. Those are significant numbers, and besides some shifting to some holdings where they think 'E' is going to grow faster, the compression in the 'P' here has been meaningful.
That's why I now find the combination of the discount and the valuation of the underlying holdings more compelling than my previous look in March.
The overall portfolio is still largely invested in tech stocks, which is to be expected as it coincides with the area of investments they are trying to focus on.
The investments are also still largely invested in U.S.-based companies. However, Europe also has a fairly meaningful allocation. Private/restricted positions are a sizeable portion of the portfolio too.
These private investments can help contribute to a discount on funds. The reason being is that level 3 assets will have somewhat of uncertainty associated with them. They may or may not be valued the same when they actually go to unload these securities. As a term fund, it is expected that they will be terminated entirely or at least partially, which means they might have to sell these positions someday. They can't just be carried in the portfolio forever until they find a buyer willing to pay the price they want.
For their restricted positions, it could also set them up to sell an asset they might not otherwise want to. It essentially takes a portion of their portfolio and makes it off-limits to sell until some future period. That isn't too much of a detriment when it is at around 10% of the portfolio, in my opinion. That should leave them plenty of other options to liquidate if they need to for the distribution.
I would also point out the acquisition date, the acquisition cost and the value as of April 30th, 2022. Cybereason, Inc.'s position has a $3 reduction in its value, and A24 Films had a $4 reduction. The rest carry the value as the exact same for each of these investments from acquisition to the value on April 30th. That is despite the sizeable sell-off in the market between the acquisition date on most of these to the reporting period. Hence, why that "private exposure discount" seems to make a lot of sense.
That being said, interestingly, the top exposure of the fund is to Grammarly, which is a part of the restricted securities.
In total, the top ten make up nearly 30% of the invested assets. Again, that reiterates the fairly narrow focus of the fund. Relatively speaking, compared to BIGZ or BSTZ, the positioning has been beneficial. A narrow focus means they have to be more right than wrong, though.
A position that investors might have noticed as odd is the NB A24 NBXG BLOCKER LLC. In the semi-annual report, they noted this:
On February 25, 2022, to facilitate compliance with certain requirements necessary to maintain its status as a regulated investment company (“RIC”), the Fund formed NB A24 NBXG Blocker LLC (the “Blocker”), a Delaware limited liability company, to hold interests in certain private placements. The Blocker is a wholly owned subsidiary of the Fund and the Fund will remain its sole member.
Admittedly, I have not heard or remember seeing anything like this in other funds. However, it is possible they do exist in other CEFs.
What is happening here is it appears that there is a certain asset that the fund couldn't hold due to tax reasons. One way around it is to set up this "Blocker," which gets taxed as a C-corp, and NBXG can invest in it without worrying about wrecking its RIC compliance.
NBXG is an interesting fund that has become more interesting with the collapse in its holdings. While the holdings are relatively more expensive than the rest of the market, the growth is also expected to be higher too. The discount on NBXG has seemed to find its bottom, which suggests that further losses from discount widening could be limited.
In my previous update, I believed the discount was attractive for the fund. I finished up that article with this conclusion:
The hard part is to know when the selling is over, and they can begin to rise again. They most definitely could continue to be under pressure through the next year as interest rates remain one of the key focuses. That being said, for a longer-term investor, that's where they can have time on their side. They can continue to invest through a dollar-cost average approach and take those distributions being paid out and reinvest them.
The final takeaway here is basically the same now. However, I now believe that the combination of the discount and the valuation of the holdings makes it a more compelling investment. I'd cautiously raise my rating from a "Hold" to a "Buy," with the understanding that this would be a higher-risk investment.
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This article was written by
Nick Ackerman is a former financial advisor using his experience to provide coverage on closed-end funds and exchange-traded funds. Nick has previously held Series 7 and Series 66 licenses and has been investing personally for over 14 years.
He contributes to the investing group CEF/ETF Income Laboratory along with leader Stanford Chemist, and Juan de la Hoz and Dividend Seeker. They help members benefit from income and arbitrage strategies in CEFs and ETFs by providing expert-level research. The service includes: managed portfolios targeting safe 8%+ yields, actionable income and arbitrage recommendations, in-depth analysis of CEFs and ETFs, and a friendly community of over a thousand members looking for the best income ideas. These are geared towards both active and passive investors. The vast majority of their holdings are also monthly-payers, which is great for faster compounding as well as smoothing income streams. Learn More.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BIGZ, BSTZ, MSFT either through stock ownership, options, or other derivatives. 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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