NBXG - NBXG: Still A Mixed Bag But It's Been Improving

2023-12-20 00:32:29 ET

Summary

• Neuberger Berman Next Generation Connectivity Fund holds a basket of growth-oriented tech stocks.
• The fund has struggled since its inception due to the poor performance of small cap tech stocks, but it's been improving.
• The fund's holdings are approaching a decent valuation, and its 20% NAV discount looks juicy.
• Still, all depends on liquidity levels and central banks' monetary policies in the near future.

Neuberger Berman Next Generation Connectivity Fund Inc ( NBXG ) is an interesting fund that is very similar to BlackRock's technology funds such as BST ( BST ) and BSTZ ( BSTZ ). It is similar to BlackRock's funds because it invests into a mix of public and private companies and writes covered calls against a small portion of its portfolio to generate income, just as several BlackRock funds do. I covered this fund a few months ago, saying that Jury Is Still Out On NBXG, as it was a relatively new fund with so much to prove.

Year to date, the fund is up 21% in share price and 35% in total returns. This performance beats S&P 500's ( SPY ) performance of being up 20% but trails Nasdaq's ( QQQ ) stellar performance as it climbed by about 50% year to date. Then again, one could argue that Nasdaq's performance was almost entirely driven by 7 stocks (also known as FAANG+ or Magnificent Seven) so it is not very easy to beat those returns without holding those stocks.

Even though the fund performed so well this year, it's still down significantly from its inception a couple years ago. The fund is down -45% in share price and -30% in total returns. One could also say that the fund didn't have luck on its side as it launched almost exactly when small cap tech stocks reached their multi-year top and entered a bear market.

There are several funds that invest in small cap technology stocks and most of them had pretty bad performances during the same period. One could actually say that this one held up a bit better than its peers since it was "only" down -30% in the last 2.5 years while its peers were down by about 40 to 60%.

Also, some of the fund's underperformance came from its NAV discount. The fund went live a couple of years ago at NAV price and now trades at an almost -20% discount against its NAV. Since its total return is down -30% since its inception, almost two third of this damage came from NAV discount rather than fund's actual underperformance.

Of course, I am not trying to make an excuse for the fund's underperformance since inception. The fund is mostly invested in a class of stocks (small cap tech) which performed badly in the last 2-3 years, and it's only natural for the fund to perform poorly during this period. At the end of the day, it all comes down to one thing which is whether you are bullish or bearish on small cap technology stocks.

Historically, the performance of small cap tech stocks is driven by liquidity levels in the overall market. When central banks are easing money supplies, these stocks tend to outperform and when central banks are tightening money supplies, they tend to underperform. This is because many of these companies are not exactly profitable and they need to have access to liquidity to be able to roll their debt.

One thing going on for these stocks this time around is that many of them had their IPOs around 2019-2021 when there was so much appetite for small cap growth stocks. This means they were able to raise so much cash from their IPOs and equity sales that many of them won't need to raise debt anytime soon. This is good for those companies but bad for investors because it means they bought stocks that were too expensive a few years ago and might be "holding the bag" for a while.

Another issue is valuations. Since many of these hypergrowth small cap tech stocks are not profitable investors don't use traditional metrics like P/E to value them. This allows them to trade at absurd valuations when liquidity levels are high and rising such as the period from 2019 to late 2021. When money supplies start tightening, investors start looking at these companies more conservatively and stop giving them a benefit of doubt so they tend to crash pretty hard. In other words, investing in small cap tech stocks is like making a bet on liquidity levels and Fed policies in the near future.

To be honest, not all of this fund's holdings are small cap stocks but many are. The fund holds some big tech stocks such as Nvidia ( NVDA ) and Applied Materials ( AMAT ) but it also holds a lot of companies that aren't even publicly trading such as Grammarly and Fabletics.

When we look at the fund's portfolio composition and portfolio characteristics, a few things jump out. First, 70% of its holdings are publicly traded and 15% are private companies and another 15% is in cash. Some of that cash is probably the covered call premiums collected by the fund to be shared with investors as dividend distributions which makes sense since the fund's yield is about 10-11%. Interestingly enough, the fund writes covered calls against 24% of its portfolio which means it participates in 75% of the upside potential in its holdings. You might be wondering how the fund generates a 10% yield when it writes calls against only 24% of its holdings but it writes calls against individual stocks instead of any indices which gives you a much higher IV premium especially considering that we are looking at high growth tech stocks. Another thing that I find interesting in this fund is that while its average P/E is 31.4, its holdings' estimated EPS growth is close to 20% which means those stocks are not particularly expensive. We are looking at a PEG ratio of 1.55 which is not too bad for growth stocks, especially considering that the overall market's (S&P 500) PEG ratio is higher than 2 right now.

I must add a word of caution on private listings though. We don't have a reliable way of valuing private companies because they don't trade in the stock market. Typically private companies' values are estimated based on the last time they raised capital. For example if a private company sold 5% of its shares to raise $50 million of capital, it is said to be valued at $1 billion. This means companies that recently raised capital will have more up to date valuations while those that haven't raised capital in the last couple years might have their values over-estimated. A fund can't easily sell its private shares and unlikely to be able to write covered calls against them so it may have to hold those private holdings until they have an IPO or get acquired which could take years.

So now we have a fund that's been deeply underwater since its inception but doing much better this year. It has a distribution yield of 10% and its holdings have reasonable valuations based on their PEG if they can keep meeting or beating growth estimates. If you are bullish on tech stocks outside of the magnificent seven, this could be a good fund to start buying but if you are skeptical of them or if you believe that central banks around the world are not done with tightening policies, you may want to wait a bit longer. Another thing that might make this fund worth a look is its deep NAV discount which accounts for a big chunk of its underperformance and could add fuel to its performance in the future if the fund's holdings started rallying and investors started to value the company closer to its NAV.

For further details see: