BIGZ - BIGZ: It's Too Soon To Judge Yet

2023-07-24 14:18:45 ET

Summary

• BlackRock Innovation and Growth Term Trust (BIGZ) has underperformed since its inception in mid-2021, but its long-term potential remains uncertain due to its evolving strategy and focus on American mid-cap and small-cap stocks.
• The fund now trades at a NAV discount of -16% after launching with a NAV premium of 15% just two years ago.
• I think it's too soon to judge this fund either way, but it's unlikely to outperform unless we have an environment similar to 2020-2021 where small-to-mid cap growth stocks outperformed.

BlackRock Innovation and Growth Term Trust ( BIGZ ) is a relatively new fund by BlackRock that's been around for just over two years. The fund has been badly underperforming since its inception, but I believe it's too soon to judge its long-term potential, and I am not fully ready to write it off yet.

The fund was launched in mid-2021 which was pretty bad and unlucky timing. Many people think last year's bear market started in January 2022 because that's when large caps and mega caps started dropping but in reality the bear market for many stocks started after mid-2021 when high P/E growth stocks and small-to-mid cap growth stocks started dropping. Large caps were the last dominoes to fall in the beginning of 2022 which caught everyone's attention, but smaller stocks had already been dropping for 6+ months by then. Below are some examples of growth stocks whose decline began months before January 2022.

In fact, this fund followed a very similar path to Cathie Wood's famous fund ARKK ( ARKK ) since its inception, performing very similarly because it held similar types of stocks.

Now things look different though. The fund now holds only about 100 stocks (down from 230s at one time) and it's more focused. The fund's top holdings look nothing like ARKK. It still holds many growth stocks with high P/E multiples but many of these companies are highly profitable and posting solid growth.

Below are the revenue growth rates of some of BIGZ's top holdings in the last 3 years. Notice how their growth rate ranges from 56% to 173% during this period, but again none of these stocks are cheap either. Many of them trade for high P/E ratios ranging from 30 to 50+.

Since this is an actively managed fund whose holdings constantly change, it's hard to judge it based on its specific holdings at any given time, but I think it makes more sense to judge its overall strategy. First, the fund invests the majority of its assets into American mid-cap and small-cap stocks, and it also has a small number of foreign stocks. The fund's description says it can invest up to 25% of its assets into foreign stocks (including emerging markets) but I've never seen them actually come close to this number. Currently, 92% of the fund's assets are invested in the US and the remaining assets are invested in Europe with none being invested in emerging markets. Still, the fund has the option to do so if it chose to shift more of its focus to foreign stocks.

Another interesting thing about this fund is that it originally started as a small-to-mid cap fund, but its strategy seems to have shifted over time. As of right now, 35% of the fund's assets are in large caps. Some of this might not be deliberate though. It is possible that some of these assets were mid-cap stocks when the fund first purchased them, but they appreciated in price since then and became large caps, but it's very rare for 35% of stocks in a portfolio to shift from mid-cap to large-cap in 2 years especially if one of those two years was spent in a bear market. It is also possible that the fund is still "finding itself" while trying out different strategies and its strategy is not set in stone yet. It's also interesting to note that the average market cap of BIGZ holdings is $12 billion which is considered large cap, but this number is skewed by some of its biggest holdings.

The fund sells covered calls on individual stocks to generate its current dividend yield of 10%. Currently, the fund's covered call ratio is only 12% meaning it only writes calls against 12% of its assets. Typically, BlackRock funds that utilize the call writing strategy tend to write covered calls against 25-30% of their position and this is the lowest one I've seen. You might be wondering how BlackRock funds are able to generate 8-10% yields by selling covered calls against only a small portion of their assets when other funds have to sell covered calls against 100% of their portfolio to generate similar yields. This is because most other funds sell covered calls on indices which have much less volatility and much less option premium while individual stocks have higher volatility and much higher option premiums, so they have better yields. This is also why TSLY ( TSLY ) can generate a 60% dividend yield while JEPI ( JEPI ) only generates about 10%.

It's important to note that the fund originally launched with a NAV premium of 15%, but now it trades at a NAV discount of -16%. It looks like investors had high hopes on this fund originally, but they lost faith over time. Also keep in mind once again that the fund was launched in Mid-2021 when ARKK type of growth stocks were very popular and investors were willing to pay a huge premium for those types of stocks, but most of that hype is gone now. Interestingly enough, the fund spent $160 million buying back its shares last year, and it plans to continue doing so while its shares trade at a deep discount to its NAV.

There are 2 things I must mention about the fund. First, it has a pretty high expense ratio of 1.36% and many investors might not feel comfortable paying a fee that high especially considering that this fund has been underperforming since its inception. Second, it's a limited-term fund that is scheduled to expire in 2033, but the fund's management has the option to convert to perpetual after that date. If the fund dissolves in 2033, investors will receive a payment in NAV value, but it is also very typical and common for these funds to convert into perpetual at the end of their term unless they end up underperforming badly.

As with most BlackRock funds, this fund also holds a number of private companies most of which can be considered as small cap or micro-cap in size. Some investors like this aspect of BlackRock funds because it allows them the opportunity to invest into pre-IPO companies that they wouldn't otherwise have exposure to, but this also comes with more volatility. A couple of years ago we'd see several successful IPOs every week, but lately it has also dried up, and I can't even remember the last successful IPO I've seen. IPOs are very cyclical in nature and their success depends on many factors including liquidity, market sentiment, overall appetite and conditions of the economy. You can have periods like 2019-2021 where many IPOs were launched one after another and made investors a lot of money, and you can have periods like last year where companies were afraid to go IPO and any company who dared to go public got punished severely.

All in all, this fund has many aspects of other BlackRock growth funds, but it's been underperforming pretty badly. I think Part of this underperformance was due to unfortunate timing and part of it was due to buying hyped up stocks at sky high valuations. In 2023, we've seen tech stocks rally hard but most of it was driven by several mega caps known as FAANG+. If small and medium cap stocks start rallying, BIGZ could start seeing some good recovery, especially considering that it has written covered calls against only about 12% of its portfolio which means it should participate in most of a recovery if it materializes.

Moving forward it's too soon to count this one out, but it's also difficult for it to outperform unless we have an environment similar to 2020-2021 where small and mid-cap growth stocks were outperforming. It is also possible that this fund will shift more and more of its focus on bigger cap stocks and make a recovery without relying on small caps, but it's too soon to tell where that could take the fund.

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