The BlackRock Science and Technology Trust (NYSE:BST) is a closed end fund which has performed well over its history. With over $1 billion under management, BST has outperformed the market since its debut in 2014. Recent market turmoil has spoiled the fun, generating steep losses as shareholders continue to flee emerging risks. Today, we dive back into the fund and focus on one unique area of BST’s portfolio.
Overview and Recap
BST is a closed end fund which utilizes a portfolio of common stock and derivatives to drive total return. At a high level, the strategy is not unique and BlackRock (BLK) offers other successful strategies which look similar. The fund has performed well since inception, but recent market action has dramatically impacted near term performance.
BST offers an interesting value proposition to income investors. The fund invests in the most successful science and technology companies, many of which do not distribute impressive dividends. BST employs derivatives and harvests capital gains to pay shareholders a consistent, strong dividend. Based on current share prices, BST offers a 6.88% yield paid monthly in the form of a $0.25 dividend. The fund has delivered on its mission thus far, as income and share prices continue to grow.
As near-term risks such as geopolitical turmoil and rising interest rates continue to ravage the market, BST has felt the pain. NAV and share price have dropped accordingly as investors’ optimism tempers. Currently sitting approximately 25% off of all time highs, shareholders have been left wondering where the incredible, consistent performance of the past five years has gone. While the sails no longer benefit from the strong tailwinds of the pandemic and low borrowing costs, the course of the ship remains strong.
As we mentioned, BST invests in some of the largest and most successful companies on the planet. The portfolio is dominated by classic FAANG companies. These companies account for a significant portion of the portfolio with Apple (AAPL) and Microsoft (MSFT) representing over 10% of the portfolio on a combined basis.
While tech continuously runs in and out of favor as optimism peaks and withdraws, the reality is that large cap tech are some of the strongest companies on the planet. Their fortress balance sheets are well capitalized and their global reach and market dominance is nearly unparalleled in any other industry. All in all, this portion of the portfolio offers stability, despite volatility. Investors with ample time horizon and stomach for volatility should continue to benefit from the growth of the world’s largest companies.
The fund is overwritten with options contracts to help generate yield. Technology is notorious for offering minimal shareholder yield as capital is generally better reinvested. Our top two holdings generate paltry yields which are honestly hardly worth mentioning as a portion of total return.
Luckily for shareholders, BST’s use of covered call options helps generate income necessary to meet the fund’s distribution. Covered calls involve selling options contracts over positions in the portfolio collecting the premium as excess return. These premiums are sent to shareholders as a component of the monthly dividend. The strategy supports the overall portfolio yield at the expense of capped upside, should a position appreciate significantly.
All in all, the portfolio is well constructed and managed. BlackRock is a capable manager who have proven their capabilities as the world’s largest asset manager. Let’s dive into a more interesting area of the fund.
As we mentioned, BST invests in private ventures as well as public equities. Referring back to the top ten holdings, readers will note there are three private investments, “Project Kafka”, “Project Shopping”, and “Project Debussy.” Other authors on Seeking Alpha have done an impressive job of uncovering information about their details. We would recommend reading their work for further information as we will not go into detail here. While they remain opaque, most are, as expected, science and technology ventures.
Many of these investments are likely in the early stages of their corporate life cycle. As such, these seed investments may offer surreal returns should their strategies play out as projected. For the fund, the upside would be significant as these equity investments are significant in size. However, with this upside comes significant risk. Private investments such as those utilized by BST are generally unavailable to the public for good reason. One of the largest risks associated with private equity investing is the inherent illiquidity. Public investments benefit from the ability to liquidate on a moment’s notice. With billions of shares trading daily across equity markets, shareholders have enjoyed the ability to enter and exit their positions on a daily basis. Private investments do not offer this feature. These investments are generally locked up for several years at an absolute minimum. For many funds, this can present problems during periods of stress.
During periods of deep stress such as the onset of the Covid-19 pandemic, market liquidity is generally one of the first things to dry up. As investors freeze or move overwhelmingly in one direction, price action becomes a significant problem as mutual funds and similar vehicles are forced to liquidate positions to return capital to shareholders. Unfortunately for these funds, there is nowhere to hide as they are forced to sell assets at market lows to support share redemptions. In the long term, this benefits nobody as many of these assets’ market prices do not reflect their real risk.
Closed end funds are different. These funds are structured as investment companies issuing a fixed number of shares at their initial offering. While shares can be issued and redeemed through certain mechanisms, closed end funds are not similar to mutual funds. Mutual funds are forced to sell positions to cover shareholder redemptions without delay. In contrast, CEF shares trade freely on the open market, meaning the fund is not actively selling position to cover investor redemptions. Instead, as investors sell their positions, share prices fall as with any other company.
This leads to a somewhat complex situation. The market cap of a closed end fund can trade far away from its net asset value. This means investors can purchase shares higher or lower than their book value.
However, for BST this offers distinct benefit. Structured as a closed end fund, BST’s investments in illiquid private companies are not exposed to the same redemption risk as traditional open ended funds. For investors, this benefit is doubled by the lack of leverage. With no exposure to sell offs and no risk of forced liquidation due to margin concerns, it would take a near apocalypse for BST shareholders to see redemption risk. Instead, BST shareholders would theoretically sell shares until they’re priced at zero. However, the fund’s investment in these companies would remain untouched as the fund’s NAV remains unaffected. We need to reiterate, this protection is structural and does not mean these investments have any higher likelihood of playing out successfully.
BST is unique in its offering of private investments. There are few other vehicles for retail investors to access private ventures. Having a nearly eight year track record, BST is a strong choice. Even sweeter is the upsized yield which has come as a return of the recent market selloff. Furthermore, the fund is currently trading at a discount to net asset value meaning shareholders can purchase assets below book value.
There are still risk factors which will play into BST’s future. The war in Europe appears far from over as Russia continues to escalate to entrench their position in the conflict. The first interest rate increase in three years has shocked investors and the market continues to digest. However, for shareholders with a long time horizon, the situation offers a superior yield.
Who knows where the markets will take us, but in the meantime a nearly 7% yield generated by a best in class portfolio will keep us happy.