BSTZ - BlackRock Science And Technology Trust: Scrambling For Traction

Summary

• BlackRock Science and Technology has been hit hard among the broader market downturn, dropping more than 50% from its peak.
• Further interest hikes, prolonged inflation and a looming recession have, and likely will, devalue the tech-heavy portfolio even further.
• The fund is scrambling for direction, abandoning its growth equity approach, which has delivered significant losses.
• BST is structured as a closed-ended fund and continues to trade above its historic 8-10% discount.

BlackRock Science and Technology Trust ( BST ) has fallen significantly in 2022. While the fund has performed well historically, returning 12.64% p.a. since its inception in 2014, I do not see this historic success continuing for two main reasons.

1. The Trust's allocation leans relatively heavily towards financial technology and semiconductors, having significant positions in Visa ( V ), Mastercard ( MA ), Klarna ( KLAR ), ASML ( ASML ), Wolfspeed ( WOLF ), and Marvell ( MRVL ). Both industries have been hit hard recently for several reasons, but a looming recession scenario and rising interest rates particularly threaten both.
2. Around 20% of the Trust's NAV are preferred securities, mostly late-stage funding rounds. While not a threat in itself, the fact that 90% of these funding rounds occurred in late 2020 and 2021, the peak of venture capital funding , represents a threat to NAV in that valuation of privately-held companies have experienced down rounds recently as can be seen by the whopping 85% down round from Klarna . Further, picking up on the rising interest rates above, IPOs for many of these investments will be significantly delayed due to the current market environment.

For stated reasons, I reiterate my "Sell" rating and forecast that BST will fall further in 2023 based on my belief that a recession and inflation coupled with high-interest rates (4-5%) will likely stay for another 12–18 months.

Overview

BlackRock Science and Technology Trust is a perpetual closed-end equity fund ('CEF'), which raises capital once upon the initial public offering. No new money will flow in, unlike for a mutual fund. The Trust will invest at least 80% of its total assets in equity securities issued by U.S. and non-U.S. science and technology companies in any market capitalization range selected for their rapid and sustainable growth potential from the development, advancement, and use of science or technology.

Holdings

BST has a very technology-focused portfolio with 47.6% in Software, 21.8% in Semiconductors, and another 10.5% in I.T. Services. The most significant positions within the portfolio are Apple (AAPL), Microsoft (MSFT), and Mastercard (MA). Together these three industries make up ~80% of the portfolio. A few significant changes are observable in the fund's securities allocation from my last article on BST, needing access to a new report from BlackRock due to their semi-annual release. However, based on their current top 10 holdings, my first thought was that the fund now looks more and more like an MSCI World fund, with the top five portfolio holdings being Apple and Microsoft, Visa, Mastercard, and ASML. Besides the point that, in my opinion, the label 'science and technology' is a bit farfetched for both Apple and Microsoft in recent years, the portfolio allocation towards more stable and larger market cap stocks came too late and will not drive the 10%+ growth necessary to match the monthly dividend that last time around many people in the comments appeared to praise. Lastly, the move towards large-cap stocks throughout the second half of 2022, away from late-stage growth equity, is a statement to them having failed with this strategy as a complement to its BST portfolio strategy. However, growth equity is not appealing in current market conditions, with few, if any, taking place.

BST Industry Distribution

Top 10 Holdings

NAV Premium/Discount

Open-ended funds can trade at a premium or discount to their net asset value (the underlying value of the stocks they invest in). Most CEFs trade at a discount, as underlined by a study conducted by BlackRock from Q2 2022, stating that the median discount amounts to ~7% over the last five years. While median discounts can be informative, it has been observed historically that CEFs trade at an individual premium/discount, meaning that CEFs trading at a 10% discount has historically remained around this threshold. CEFs do not always trade at par with their NAV and can be volatile because of recent NAV performance, brand recognition, or changes in the attitude towards the investment theme. As of January 6th, BST trades at a 0.95% discount, which is surprising given the above reasons, as the discount tends to increase in a market downturn. While this has been the case for BST, with NAV down 36.84% and the market price down 37.43%, the discount is almost at par. Since my first article, the small premium of market price has already vanished, and I expect the discount to widen further, with BlackRock themselves stating that CEFs tend to return to historic premiums/discounts, which in their case, ignoring the volatile markets of 2020 and 2021, stands at around -7%.

Rising Interest Rates and Venture Investments

As mentioned in my thesis above, I expect interest rate hikes to continue for the foreseeable future and to remain at a level of ~4% for around two years. I do not claim to be a macroeconomic mastermind capable of forecasting when precisely the tipping point is that rate hikes stop since a plethora of factors influence this decision, among them the future development of the Russia-Ukraine war for energy prices as well as how supply chain constraints will continue to develop over the next 12 months. However, rate hikes will continue in the U.S., and they have only started in Europe, with the ECB announcing a 75 basis point rate hike just today. As is commonly known, this affects technology stocks the most as they have the highest growth estimates. While I am convinced that this has mostly been priced in for the common stocks the Trust holds, I do not think the same has happened to their venture investments just yet, with valuations potentially crumbling as was the case for Klarna, a whopping 2% of the portfolio, which had to suffer a down round of 85% and added liquidation preferences, favoring the most recent investor in case of bankruptcy. While evaluating each venture investment would not be feasible due to the unknown ticket size and stake, what can be said about their investments is that the tickets that were written mostly date to 2021 or late 2020, as stated in the semi-annual report . 2021 represents the peak of venture capital investing, with valuation having been at the highest they ever were. Private-market investments, unlike public-market investments, are not continuously valued. As these ventures seek new funding due to the worsening IPO landscape, down rounds will likely continue to occur, and with that, the value of BST's investments will likely decline even further.

Conclusion

BST historically has shown superior performance in a market environment with near-0 interest rates. However, market conditions have worsened, putting Trust under the gun, dropping 40% over the last year. I do not see a recovery for the underlying securities and find it more likely that NAV will fall further before a true bottom has been found. As mentioned a couple of times, the value of the Trust is significantly bound to future interest rate development and the fund's ability to buffer the adverse effects with its options strategy.

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