STK - STK: High Income And Excellent Growth But Is It A Buy?

2023-12-18 09:00:00 ET

Summary

• Columbia Seligman Premium Technology Growth Fund is a closed-end fund that primarily invests in technology companies, offering high income and growth potential.
• For 14 years of its existence, it has offered nearly 14% of annualized total returns, never cut its distributions, and is paying 6.2% in distribution income.
• We believe it is an excellent fund for income investors; however, we would rate the fund as "hold" mainly because it is trading at a significant premium, and new buyers may want to wait for the premium to come down a bit.

Last week, we provided an analysis of BlackRock Science and Technology Trust ( BST ), which you can read here . This article will cover another fund that is similar in nature and its goals but also different in many ways. The fund we are going to cover is Columbia Seligman Premium Technology Growth Fund ( STK ).

The fund was incepted in November 2009 as a perpetual equity closed-end fund, or CEF . As per the fund's literature :

"the fund targets long-term capital appreciation and current income with a portfolio of technology stocks and an option overlay strategy designed to mitigate downside volatility and generate income. The fund managers use a rules-based strategy to construct a concentrated portfolio designed to provide growth and current income while mitigating downside volatility. It selects investments based on rigorous bottom-up fundamental analysis and valuation analysis, using a growth-at-a-reasonable-price style to aim for more consistent performance and lower risk than its peers."

Other salient features of this fund are as follows:

• Seeks high growth: The fund has a flexible mandate to invest in technology companies of all market caps, countries/regions, and industries.
• Concentrated but fairly diverse exposure: The fund can invest globally; however, it is mostly invested in the U.S. based technology companies. Compared to its peers, it is a bit of a concentrated fund as it only held 61 positions as of Oct 31, 2023.
• Aims to reduce volatility and generate income: The fund seeks to reduce volatility by writing Call Options on the NASDAQ 100-Index (NDX) or its exchange-traded fund ((ETF)) equivalent on a month-to-month basis. The aggregate notional amount of the call options can typically range from 25% to 90% of the underlying value of the fund's holdings of common stock.
• The fund uses zero leverage and manages roughly $470 million worth of assets. As of Oct 31, 2023, it had 61 individual holdings; however, the top 10 holdings represented nearly 43% of the total assets.
• The fund is an actively managed fund and has an expense ratio of 1.13%.
• As of Dec. 12, 2023, its distribution yield on the market price was 6.20% and 6.57% on the NAV.
• As of Dec. 12, 2023, the discount/premium to NAV was +6.27%, which is a tad below the 6-month average discount/premium of +7.43%; however, higher than the 3-year average of +4.12%.

Is the fund a better investment than Technology Index funds?

So, why invest in a fund like STK, with its high fees of 1.13%, when you can buy technology index funds (or equivalent ETF) at much lower fees? Well, there should be two reasons: income and lower volatility. However, from the past record, we do not see much difference in the volatility, so that leaves one strong reason, and that is high income while not skimping on growth.

Who should invest in STK over a Technology Index fund (ex., Invesco QQQ Trust ETF )?

If we were to compare the performance (total returns) of STK with a Technology ETF like QQQ , over the last 14 years, STK underperformed QQQ by a couple of percentage points. Interestingly, most of the underperformance was in the initial years of STK. However, starting in 2014, it has outperformed QQQ by a few percentage points, so for total return investors, it may be beneficial for diversification purposes. However, for income investors, income is the most important factor.

So, you should prefer STK over QQQ if:

• Income (from investment) is very important for you and is either needed right now or will be needed in the next few years.
• Do not like the idea of selling shares (of an investment) to raise income, as it causes too much uncertainty and emotional stress.
• If the income is important to you, but you do not want to miss out on growth, then this fund is for you.

Financial outlook:

Let's look at the Fund's Financial health and performance. The most recent detailed report that is available to investors is the semi-annual report for the period of Jan - Jun 2023.

• Net Investment Income:

Per its mandate, the fund is heavily invested in technology companies, which are generally NOT known for their high dividend. Many of them do not even pay dividends. So, a fund like STK has very little investment income coming their way from dividends. To generate some additional income, the fund writes Option Calls on a part of the value of their holdings. The extent to which they write covered calls can vary depending on market conditions, but as stated earlier, at the end of June, it had calls overwritten on 49% of the underlying assets. So, it produces some of the income but not enough to count on to pay distributions. In fact, the investment income is mostly consumed by the fund's expenses and some more, resulting in negative NII (net investment income).

Here is what it looks like in terms of NII, Distributions, and Net Assets at the beginning and end of the statement period.

(all amounts are in US $ (except Shares Outstanding) for the 6-month period; negative amounts are shown inside parentheses, per the semi-annual report, six months ending 30th June 2023).

Table-1:

As we know, the technology sector has done pretty well in 2023 after a disastrous 2022. STK also had a huge negative year and lost 30% of its value in 2022. However, in 2023, on the back of tech recovery, it has gained back nearly 42% until Dec. 13, 2023, based on market price.

Distributions:

Note: The fund recently announced a special distribution of $0.2669 per share, payable on Jan. 23, 2024. The ex-dividend date is Dec. 15, 2023, which would likely be in the past by the time you are reading this article.

Just like other technology equity funds, the fund offers the best of both worlds: growth and reasonably high income. However, this fund provides quarterly distributions (unlike BST, which provides monthly payouts). Sure, if you do not need income today or in the near term, there may be many other good options to invest in the technology sector.

STK provides a quarterly (managed) distribution of $0.4625 per share, which comes out to be a yield of 6.20% at current prices (as of 12/08/23). It has kept the quarterly distribution amount the same over the last 14 years. However, it has also provided special (variable) distribution in five of the 14 years, including 2023. We will say that the fund's management has done a good job of managing the right balance in terms of distributions and has never had to cut the distributions. Many times, it is tempting for the managers to overpay the distributions that do not turn out to be sustainable.

So, is the distribution covered?

Not really, but it does not matter much for a fund of this type. It is an equity fund that invests in technology stocks. On top of that, the fund uses no leverage, which is a good thing. However, as far as investment income goes, we know that technology stocks are not known for dividends. In fact, a majority of them don't even pay dividends. But as stated earlier, the fund writes some covered-call options on the part of its portfolio value. Since the fund has fairly high management fees (total fee at 1.13%), all of the income that is generated is consumed by the operating expenses and fees. So, distributions are almost always paid from capital gains or appreciation and, at times, by way of return of capital.

That said, it is a technology fund, and it is heavily invested in stocks that are likely to provide high growth and capital appreciation, usually faster than what it pays in distribution. So, in this case, we should not be overly concerned about the coverage, especially when the management has managed this quite well in the past.

Discount/premium:

The fund is currently trading at a premium of over 7% (to its NAV). But if you look at its 5-year history, it has traded at an average premium of 3.28%, so the current premium is more than twice the average. So, this is the big negative with the fund right now as it appears expensive. Can it still trade even at higher premiums? Sure, anything is possible, but that won't last for very long as the yield (on market price) will start falling to unattractive levels.

Overall, due to the types of holdings it has, it is likely to provide decent to good growth. It is trading at nearly 20% below its peak in 2021. However, the prospects of this fund (as the technology sector, in general) are heavily dependent on the path that the Fed will take in 2024. As all indications currently point to multiple rate cuts in 2024, the tech sector may have a banner year.

Chart-1:

Courtesy: CEFConnect.com .

Funds holdings:

The fund is fairly diversified and currently holds 61 positions (including individual stocks and call options). That said, in comparison to its peers like BST, it is fairly concentrated. Its top 10 public holdings include Lam Research (LRCX), Apple (AAPL), Microsoft (MSFT), Broadcom (AVGO), Alphabet (GOOGL), Applied Materials (AMAT), Synopsys (SNPS), Visa (V), Teradyne (TER), and Dropbox (DBX). The top 10% of holdings account for slightly nearly 43% of the assets.

Table-2:

Courtesy: Columbia/Fund's website.

Comparison with BST (BlackRock Science and Technology):

Note: Most of the above data is taken from Morningstar.com.

Risk factors:

Investors need to be aware of certain risk factors that are associated with this fund. The near to mid-term future performance of STK is somewhat tied to the movement of interest rates. However, as of now, all indications are pointing to multiple rate cuts in 2024; we expect STK to perform pretty well, barring some unforeseen situations.

Risk factors could be summarized as follows:

• The macroeconomic conditions and the movement of interest rates in 2024.
• The geo-political situation.
• Fallout (if any) on the technology sector, especially in the semiconductor segment, from the tense relationship between the U.S. and China.
• The occurrence of a recession in 2024, however, is likely to be a shallow one by most estimates.
• Relatively high fees of 1.13% on a zero-leverage fund. All things equal, these fees take a cut from the growth of the fund.

Concluding thoughts:

Should you invest in the STK fund?

We think you need to answer this question first: are you an income investor or a total-return investor? If you are an income investor or a retiree (or approaching retirement) who depends on regular and reliable income month after month (maybe every quarter), then both STK and BST are definitely great investments. The only question would be at what valuation and/or discount/premium should you invest?

Funds like STK and BST offer the best of both worlds: reliable and steady income and decent growth of capital that will easily beat inflation and help you maintain your living standards.

Many times, we have heard the argument that why can't we sell shares to generate income? If you can do that effectively, sure, this fund is not for you. But for most investors, we have seen that it is very difficult to emotionally deal with selling their shares to generate income. You do not want additional stress dealing with issues like when to sell, how much to sell, and other what-if scenarios. So, for income investors, STK should certainly be a worthy candidate. However, just like any other CEF, the timing can be somewhat important with respect to discount/premium (unless you are dollar-cost-averaging).

Since its inception in Nov. 2009, the fund has paid $25.90 in distributions (not counting the special distribution of 2023), which represents more than 100% of the original investment (inception price $20 a share).

Is it the right time to buy STK? Due to the high premium (significantly more than its five-year average), we are rating the fund as a "HOLD." It may be too expensive for the new buyers (or existing shareholders to add), and they could wait for the premium to come down somewhat. For the existing shareholders, it is a hold but not a sell. In comparison, BST is trading at a cheaper valuation right now, but its portfolio composition is not a 100% match with STK.

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