STK - BST: High Yield With Prospect Of Strong Capital Gains

Summary

• BlackRock Science and Technology Trust aggressively increased the number of holdings in the fund in January, a move that could potentially enable it to capture the strong gains in tech stocks in January.
• BST stands to gain from a continued recovery in tech stocks, which should lead to capital gains on its portfolio and help sustain its generous monthly distributions.
• BST currently yields 9.5%, making it an attractive pick for income-oriented investors.
• The current share price, which is closer to its 52-week low than high, also points to the possibility of decent capital gains if tech stocks recover.

Investors betting on a recovery in tech stocks can consider BlackRock Science and Technology Trust ( BST ), a $1.03 billion (assets under management) closed-end equity fund ("CEF") that invests in science and technology companies globally. It is run by BlackRock, Inc. ( BLK ), the world's largest asset manager, and pays a generous monthly distribution.

Like other tech-focused funds, BST had a dismal 2022 and, despite a +10% YTD run, is down 26% over the past 12 months due to the adverse impact of inflation and interest rates on tech stocks' valuations over the past year. BST's decline over this period has led to a substantial increase in its yield, which currently stands at 9.5%. This makes BST an attractive pick for income-oriented investors looking for superior returns in a high interest rate environment. Importantly, the downside risk for investors who take advantage of the current price is limited. Tech stocks in my opinion reached their nadir in October 2022 when the Nasdaq Composite sank to around 10,400 points.

According to BST's fact sheet , the fund seeks growth by investing in current leaders and emerging winners in the science and technology sectors. Unlike the Invesco QQQ ETF ( QQQ ), which tracks the Nasdaq 100, BST does not track any index but invests in technology companies across various market caps and regions. BST doesn't also employ the use of leverage - a common practice with many CEFs - to enhance returns. It instead sells call options on its underlying portfolio to reduce volatility.

Well-timed shopping spree amid tech recovery

As at Jan 31, 2023, BST had 573 holdings . Its top holdings are Apple Inc. ( AAPL ) with a leading 6.85% weight, Microsoft Corporation ( MSFT ) with a 6.29% weight, Mastercard Incorporated ( MA ) with a 3.42% weight, ASML Holding N.V. ( ASML ) with a 2.71% weight, and Nvidia Corporation ( NVDA ) with a 2.50% weight, among others. In terms of sectors, BST is overweight software and semiconductors, which accounted for 46.09% and 21.50%, respectively, of sector exposure as at Jan 31.

Curiously, BST had 121 holdings as per its December 2022 fact sheet vs. the 573 it reported at the end of January. BST basically went on a shopping spree in January, potentially capturing some of the incredible January gains. The recent rally in January saw the Nasdaq 100 gain 10.6%. This rally marked the strongest January on record since 2001 and the best single-month return since July 2022.

Assuming tech stocks sustain their recovery in 2023 - with inevitable volatility along the way - BST could be well-positioned to benefit. Its move to buy aggressively in January when the recovery began could in retrospect make a huge difference in terms of the return profile of its holdings. Timing the market is not a strategy, but when it works, it is an absolute gamechanger. Investors could, therefore, do well to take advantage of BST's current price, which has appreciated by just 10% YTD.

Moreover, BST is trading at around $31 per share vs a 52 week range of $27.45 - $44.78. It doesn't take much analysis to deduce that the risk reward profile is compelling given how strongly tech stocks have started the year and the fact that BST is still much closer to its 52-week low than it is to its high. In the event that the bullish thesis for tech stocks plays out through the year, the returns for those who build a position at current prices or lower will likely be incredible.

When it comes to income, BST is a compelling pick because it has a strong track record of consistently growing distributions since its inception in October 2014. It boasts a 5 year dividend growth rate of 17.49%, which is impressive.

BST pays its dividends from capital gains on its underlying portfolio and selling call options. In periods of negative returns, it also sustains dividends through return of capital. The fact that BST did not cut its dividend in 2022 when tech stocks plummeted is a reassuring indicator that the management team can maintain the needed level of liquidity in different market environments. Moreover, assuming tech stocks continue recovering in 2023, it is likely that BST will be able to sustain an steady pace of dividend growth for the foreseeable future.

Competitive advantages over peers

Thanks to its current 9.5% yield, BST has competitive advantage when compared to other tech-focused funds that pay dividends such as Columbia Seligman Premium Technology Growth Fund ( STK ), which has a 6.9% yield. Why should I own STK when BST offers a higher yield that is secure?

BST also has a relatively long track record, having been launched in 2014. Many income funds focused on tech sprang up in 2017 -2019 when the tech bull market was raging. A longer track record is certainly reassuring. The current gross expense ratio of 1.05% is also reasonable in my opinion.

BlackRock's' brand recognition and expansive global operations are also an intangible strength. Whether its access to data, networks with senior business executives and experts or the use of the latest sophisticated analytical tools, you can count that BlackRock, as the largest asset manager in the world, has some kind of edge over most of its peers. This can help drive higher returns, hence helping to sustain BST's dividends.

Another important differentiator for BST is that, unlike most CEFs, it holds stakes in private companies. These venture capital deals can be highly profitable and help drive differentiated returns.

Be mindful of the risks

As a bullish investor who has lost hard-earned money in some of my previous investments despite optimistic views of the future, I always like to have a clear appraisal of risks when investing in any opportunity.

When it comes to BST, the first risk worth noting is its participation in private placements. While these deals can be highly profitable, they are a double-edged sword. Private investments are illiquid when compared to public equity and more vulnerable to downturns in case investment appetite sours. When IPOs dry up and valuations in venture capital markets decline as they did in 2022, serious losses can be incurred. This risk can, however, be mitigated by proper position sizing and diversification.

The other risk is that interest rates terminate at a rate that is higher than currently expected or stay higher for longer, dashing hopes of an anticipated rate cut. This could lead to correction and possible slump in tech stocks, bringing down BST. The Fed may hike interest rates to nearly 6% (about 50 basis points higher than current expectations), Bank of America ( BAC ) Global Research recently said. This is due to strong consumer demand and a tight labor market, which could keep inflation high despite recent rate hikes.

If BofA's prediction comes true, BST investors could suffer losses on their capital in the short-term. This prediction doesn't, however, change my view that tech stocks will recover in 2023 or at the very least outperform 2022's disappointing returns. For this reason, I am bullish on BlackRock Science and Technology Trust which will likely gain value if tech stocks recover.

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