BSTZ - BSTZ: I Am Buying The Deep Discount In This Fund

2023-05-22 18:57:42 ET

Summary

• BlackRock's BSTZ fund currently trades at a -17% discount.
• It also pays 11% dividend while investors are waiting for share appreciation.
• This is a good fund with a lot of potential. The fund combines investing in private companies with writing covered calls to provide opportunities that are hard to replicate.

BlackRock Science and Technology Term Trust ( BSTZ ) is an interesting fund with unique characteristics. The fund owns a very large number of tech stocks of a variety of sizes, it invests into private companies that aren't publicly traded, and it sells covered calls against some of its positions in order to generate dividends for income seeking investors. It seems to offer it all, and we are also witnessing a comeback of tech stocks with Nasdaq being up 21% year-to-date, but investors have been selling this fund off which creates a buying opportunity not seen since the fund's inception in 2019.

The fund currently sells for a discount of -17.43% against its NAV, which has at least two implications. First, when you buy this fund, you are buying each dollar's worth of asset for 83 cents. The second implication is that the dividend yield is also amplified because you are getting $1.17 paid for each $1.00 the fund generates from its assets. These types of discounts are rare and should be taken advantage of.

Some people argue that this fund's NAV calculation might be a little off because it invests 25% of its total assets into private companies not publicly traded. Since those companies are not publicly traded in a stock exchange, it is difficult for us to know their exact value day to day. Many times private companies will take in new investors for their private shares or their bond and this will determine what their implied value is at the time. For example, if a privately held Company A sells 10% of their shares to an investment bank for $500 million, it is said that the company is valued at $5 billion based on this transaction. This is different from valuing a company based on millions of transactions that happen every day on the stock market, where shares are constantly changing hands. Still, this doesn't make those private companies less valuable.

In fact, private companies tend to either sell for a premium or have an IPO at a premium price when their time comes. If anything, most private companies end up with higher valuations than their initially assessed value by the time they mature and get either sold or IPO'ed. Also, since private companies mostly get traded by large investment firms that typically run deep fundamental analysis before buying and hold them for many years after buying, they are less likely to reach bubble valuations driven by markets and their constantly shifting sentiments. This is why I am not too worried about valuations of private companies held by this fund.

One note of caution I must add is that the fund doesn't specify exactly which private companies it owns shares in, so you have to have faith in BlackRock's ability to pick good private companies to invest in if choose to invest in this fund. This fund isn't for those investors who want to know exactly what they are buying with full certainty, but it is a good fund if you can deal with some uncertainty and trust the company issuing the fund (BlackRock).

Another thing that makes this fund unique is their approach to writing covered calls. Most covered call funds (such as QYLD, XYLD, JEPI, JEPQ) write calls on indexes against 100% of their positions. This fund writes covered calls on individual stocks they hold and only for a fraction of their total assets so that investors can participate in any upside as well. For example, from the bottom of March 2020 to the end of 2021, this fund's share price appreciated by 220% while most covered-call funds didn't participate in this upside because they sold calls against all of their positions.

Currently, the fund's coverage ratio is as low as 26.53% which means that for every $100 of assets it owns, the fund is currently writing calls against $26 of those assets and allowing the remaining assets to run higher. What is impressive about this is that the fund still supports a dividend yield of nearly 12% despite selling covered calls on only a fraction of their assets. Part of the reason could be that individual stocks tend to have much higher IVs (implied volatility) than indexes, so the fund is able to generate a much higher premium than it would if it was writing calls against indices like QYLD and JEPI have been doing.

Just to give an example, currently the IV value of SPY is 14 and IV value of QQQ is 18, meaning one could generate about 10-12% premium by selling options against SPY and QQQ. In comparison, Nvidia's (NVDA) IV is 47, Tesla's (TSLA) IV is 45, Google's (GOOG) (GOOGL) IV is 27, Amazon's (AMZN) IV is 29. Mind you that these are mega cap stocks. Small cap and medium cap tech stocks tend to have even larger IVs. For example, Roku's (ROKU) IV is 58, Zoom's (ZM) IV is 67 and SQ's IV is 47 (source for these IV numbers: volafy.net). One can generate about 2 to 3 times as much premium by selling covered calls against some individual stocks than against indices. This is probably how the fund is able to generate a yield of 11% by only having a coverage rate of 26%.

Since it was created in 2019, the fund hasn't been around that long, so it's hard to tell how it will perform in the long run. From its inception to the end of 2021, the fund returned about 220% in total returns in just 2.5 years. Since the beginning of 2022, it's been struggling and gave up all its gains, partially because of the drop in tech stocks and partially because it went from trading at a premium to trading at a deep discount. You might say that Nasdaq is making a comeback and tech stocks are roaring again, but this performance is mostly limited to mega caps like Apple, Microsoft, Nvidia and Meta. This fund owns a lot of small, medium and large cap stocks as well as privately owned companies, so its performance lagged behind in the last 6 months while FAANG stocks carried indices higher single-handedly.

It may take a while before small cap and medium cap technology stocks start participating in this rally started by mega caps, but it's ok because the fund pays a pretty high dividend for you to wait, so you are not totally relying on a recovery either. In fact, if you are reinvesting your dividends at the current deep discount of -17%, your dividends are buying back 17% more shares than they normally would if the fund was trading at a NAV, so you are actually taking advantage of a sale.

I must add that although this fund hasn't been around for that long, it has a sister fund ( BST ) which has been around for a decade. This fund uses a similar methodology and resulted in about 15% in compounded annual growth rate for investors, including reinvesting of dividends. As a matter of fact, this fund's compounded annual growth rate was closer to 20-25% until last year's crash in tech stocks. I am long both BST and BSTZ, but I am adding to BSTZ because it is trading at a -17% discount to its NAV, while BST is pretty much trading at its NAV value.

Regardless, investors should be well-diversified and never put more than 10% of their assets into one fund. If investors would like to start buying this fund, they can start with a small number like 1-2% of their portfolio value and slowly build their way up over time, especially if bigger buying opportunities present themselves over time.

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