BIGZ - BIGZ: 15% Discount To NAV And 6% Annualized Distribution

2023-11-10 11:51:38 ET

Summary

• Closed-end funds offer investment opportunities at a sizeable discount to net asset value.
• BlackRock Innovation and Growth Term Trust is a closed-end fund with a 15.18% discount to NAV.
• Boaz Weinstein, a successful investor, has been advocating for better governance in BlackRock closed-end funds.
• The BIGZ fund has initiated a buyback program which seems to work to mitigate the discount.

Closed-end funds, or CEFs, are a niche investment class that most investors overlook. There are usually myriad special situations ongoing in that space, especially if you're willing to look outside the U.S. There are interesting situations in the U.S. too, though, and one involves the BlackRock Innovation and Growth Term Trust (BIGZ). Closed-end fund nemesis Boaz Weinstein has it in his crosshairs as the 2nd largest position.

I don't focus on closed-end funds exclusively (far from it), but I like to buy them occasionally at big discounts. Most years, I like to add a few to my portfolio near year-end. Often, there are bargains around for reasons that are beyond my understanding. The FT has an article out today talking about the large average discounts observed in the U.K. market (where I've historically found the best ones).

The FT seems to think it has something to do with TINA ending and there now being yield alternatives like U.S. treasuries. That's part of the reason, but it is also much harder to sell these right now. Closed-end funds tend to get sold to investors at full price. That's when they tend to trade at NAV or even above NAV. Older issues tend to trade at a discount.

The NAV discounts I'll run with depend on various factors, including the fund's management, investment strategy, and asset composition. Asset composition is a biggie. On a fixed income fund , I can be okay with an 8% discount to NAV. Buying Bitcoin (BTC-USD), I was ok with a bigger discount like 40% NAV. I've also bought illiquid failed hedge fund assets in Brazil at an ~80% discount to NAV. In general, I opt for smaller discounts when considering fixed-income funds, and liquid equity funds and look for deeper discounts for equity or private equity funds. I prefer it if the fees aren't too high. In this case, the gross management fee is 1.36%, which is modest regarding CEFs.

I always look at the portfolio closely. It's not because I want to 2nd guess managers, but it serves multiple purposes:

1. You'll see whether the fund's management is closet-indexing (If you are in for the long exposure and the fees are high, this isn't great). Skilled managers tend to craft creative and unique portfolios. It will have lots of names I don't recognize. If you can back truly skilled managers that helps a lot with this strategy.

2. Occasionally, I may not love the fund, but the portfolio can still contain interesting ideas I can check out independently of this investment.

3. I often want to hedge the exposure if I'm purely in for the discount narrowing. Sometimes (like in this case), you'll also find you can't fully hedge the portfolio of what, on the surface, appears it be a fairly straightforward fund.

A very important thing to take note of is that the fund has plowed 26.2% into private ventures. The venture investments cover the gamut from consumer staples, discretionary, communications, energy, financials, industrials, and technology. All of these have been marked down from when they made these investments. Some by over 50%.

Boaz Weinstein has recently been badgering BlackRock, Inc. ( BLK ) to step up its game regarding the governance of its closed-end funds. Weinstein has a good track record of making things happen. A recent example is the Citadel Income Fund. I'm unsure if it is due to his noise, but BlackRock has recently started buying back shares at a swath of its closed-end funds. There is an interview by my fellow contributor Michael A. Gayed with Weinstein on YouTube that's very good, and where he goes into his views on BlackRock's policies.

BIGZ's investment objectives are the same as almost any other CEF: to provide total return and income through a combination of current income, current gains, and long-term capital appreciation. Its managers try to achieve this by focusing on mid- and small-capitalization growth companies. Then, they sell calls. They vary the call selling depending on outlook, but currently on around 12% of these companies.

Management also employs some leverage (currently ~3%) and has a large allocation to illiquid private venture-type investments. The fund is also marketed as an ESG fund, incorporating ESG data into its overall investment process. This is mostly relevant because it needs to be factored in when looking for efficient hedges. Theoretically, you could hedge out the precise portfolio, but I use one or more (if necessary) ETFs that approximate the portfolio in practice. This saves a lot of trading costs and time, but it tends to be a dirty hedge.

BIGZ trades at a discount of 15.18%. The fund is also on a contingent limited-term structure, which I haven't seen much before. This means it has a set termination date: March 25, 2033. As the date approaches, the discount is likely to close as the fund could be wound up by that date, which would eliminate it. It is a long time to wait, and I'd prefer not to, but practically it adds roughly 1.6% of returns on top of the NAV's return. The fund also pays a monthly distribution, adding up to an annualized rate of ~6%.

I think this fund is very interesting here because of: 1) the sizeable 15% discount; 2) Weinstein's activist work; 3) the fact that buybacks were initiated at BIGZ and other BlackRock funds; and 4) If you hedge out the ESG growth portfolio, you get VC exposure that's otherwise not easy to get into a portfolio.

I'd sell out if the discount to NAV closed some and stabilized at a lower level. It is unlikely to go and trade at NAV, but it could go to a 5%-10% discount, and that is a very good result if you hedged out the market risk. It translates into gains of 5.2%-11.11%. If you short an ESG mid-cap growth ETF against it, this will require no capital. It only requires a margin. Be mindful of the risks associated with a position like this, though. I pulled up one mid-cap growth equity fund (no ESG but managed by the same firm) and the correlation between the two varies.

It is possible, at times, that the short position goes against you and the long position as well. This can be very awkward if you invest with leverage. The long position will include venture capital-type investments. If we're going into a period where the stock market strongly outperforms BIGZ venture picks this can also end badly. There are also borrowing fees to be mindful of. Very specific ETFs can be hard to borrow. Sometimes it will be better to hedge with something that's less correlated but simply much cheaper to borrow like a Russell growth ETF or the NASDAQ. The biggest risk if you hedge well and can withstand some volatility in the position is that the discount simply does not close or even widens. It is currently narrowing and given the activist presence, this isn't my expectation, but it can happen. That's when you can get stuck in a position for a long time while not generating any return. The opportunity cost of that happening is real, so it is wise to periodically check in if things are still progressing in the right direction.

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