JEPI - STK: Outperforms Indexes While Providing Superior Dividend Income

2023-12-13 23:33:53 ET

Summary

• Columbia Seligman Premium Technology Growth Fund focuses on investing in the technology sector with strong growth prospects and attractive valuations.
• STK deploys an option strategy that provides a high dividend yield of over 6% and has outperformed competitors in terms of price appreciation and NAV growth.
• The fund rewards shareholders with special dividends coming from the year's realized gains.

Overview

The Columbia Seligman Premium Technology Growth Fund ( STK ) is a closed-end equity mutual fund managed by Columbia Threadneedle. The fund focuses on investing in the technology sector within public equity markets. The fund strategically built its portfolio using a specific set of criteria to filter out its holdings. These criteria are strong growth prospects, attractive valuations, and consistent investment returns.

I like STK as a majority of the fund is weighted towards "growthier" tech companies that can provide a nice upside while simultaneously providing a dividend yield over 6%. The reason that STK can provide such a high yield is because it also deploys an option writing strategy to beef up the returns. Looking back, we can see the total return has been excellent over the last decade compared against the S&P 500 ( SPY ) and Invesco's QQQ Trust ( QQQ ).

The fund is also pretty cost efficient. There is a management fee of 1.06% and other fees of 0.7% which brings the total annual expense to 1.13%. As an investor that focuses on dividend income, there are times where my portfolio is underweight in technology holdings. Tech companies often do not opt to pay out dividends. If they do, they tend to only provide tiny yields that are often immaterial in my portfolio. I recently wrote an article on Apple ( AAPL ) and how having exposure to some of these growthier tech companies is important for portfolio balance. Having the ability to generate income from a set of holdings in this space is exactly what a balanced dividend portfolio needs. So let's dig in and analyze why this fund has earned a spot in my portfolio!

Structure & Portfolio

The fund primarily allocates its assets to growth stocks within the technology sector, accounting for approximately 80%. This is followed by communication at 11% and industrials at 4%. More specifically, 35% of this tech makeup consists of companies with exposure to the semiconductor industry. This allocation definitely assists to capture the upside movement as the semiconductor space has seen some incredible growth.

In addition, STK management employs a bottom-up fundamental analysis. They utilize a valuation models to identify growth stocks that are reasonably valued in comparison to their industry peers. The process results in STK having 61 individual holdings. Here are a list of their top holdings (by % of net assets):

As previously mentioned, the fund engages in the strategy of writing monthly call options on the Nasdaq index. It's important to note that this isn't a "covered call" approach since the fund doesn't hold the index itself; instead, it maintains a distinct set of stocks against which it writes call options. Something that gives me a strong sense of confidence in their strategy is that they assign the highest weight to stocks in which the company's management team has the greatest conviction. This helps to create a portfolio with an emphasis on their most confident investment choices. Looking at the historical performance, this strategy actually does work.

Given its active management approach, the fund has the flexibility to write call options against a portion of its total asset value, ranging from 25% to 90%. The decision on the extent of call options written is influenced by factors such as overall market volatility and valuations. In times of heightened volatility, the fund may opt to sell more call options to capitalize on inflated premiums. Conversely, when the management expresses optimism about the stock market, they may choose to write fewer calls to avoid capping potential upside. This is why the fund is able to provide special dividends that come from realized gains at the end of the year.

Dividend & Valuation

As of the latest declared quarterly dividend of $0.4625/share, the current dividend yield sits around 6.2%. As previously mentioned, they are able to sustain a higher yield because of the option writing strategy deployed. STK also recently announced a special dividend payout of $0.2669/share payable Jan23 of 2024. As previously mentioned, the special dividend comes from the realized gains throughout the year.

For reference, the special dividend at the end of 2022 was significantly higher at $1.0819/share. This speaks volumes to the efficiency of the managers who run the fund as 2022 is when tech stocks were all falling from their 2021 highs. Even with the market downturn, they were able to provide shareholders with a nice year end bonus. Historically , the fund has out-earned their distributions and I don't see the dividend sustainability as an issue going forward.

STK has historically traded at a slight premium over its NAV. At the moment, the price trades at a slight premium to NAV of 6%. The average premium over the last 3 year period has been approximately 4.11% over NAV. This means that the price is currently "expensive" from this standpoint and entry here may not be as attractive historically speaking.

However, I still plan to initiate a position here as we've seen spikes where the price has traded at a premium of 10% - 13% even before the crazy spike of 2021. Therefore, this is a premium level that I am comfortable with. In the scenario of a price drop, I would simply continue to DCA (Dollar Cost Average) my position with additional funds as well as the reinvested dividends.

Stand Out Performance - Comparison

What makes STK stand out against competitors such as JPMorgan Equity Premium Income ETF ( JEPI ) or BlackRock Science and Technology Trust ( BST ) is STK's stellar performance over time as a fund that deploys an option writing strategy. I think that a lot of funds, especially closed end funds, that deploy an option writing strategy, have the reputation that the NAV and share price erodes over time. This has definitely been the case for a lot of these option funds but with STK, the price appreciation, NAV growth, and dividend growth has been nothing short of amazing. Just take a look at the total return compared to these funds:

JEPI and BST both have a much higher dividend yield but still, STK outperforms because of the consistent price appreciation and the way the fund is structured as a CEF (Closed End Fund). We can see how the growth of $10,000 plays out between the price and NAV. A $10,000 investment would now be worth $60,000 while also providing you $3,313 in dividend income, assuming dividends were reinvested during this time span. This would equate to a yield on cost of approximately 33%.

Risks

There are some potential downsides to the fund, though. For example, there is a large exposure to the semiconductor industry. The industry has seen a lot of growth and there are quite a few analysts that believe the sector is currently in over-valued territory. As a reference, take this analysis by Ricardo Fernandez that digs a bit deeper into the sector and the valuations heading into 2024.

In addition, the higher distributions are not classified as qualified dividend income. Therefore, you may experience taxable impacts as you grow a position size. If you want tech exposure, QQQ is a solid pick, but the income it produces pales in comparison with a yield of only 0.54%. The income generated from option writing is generally classified as ordinary income, as opposed to qualified dividends. Underperformance of the NASDAQ is also likely here because of the structure of the fund. The NASDAQ is up over 41% YTD, while STK is up 33% over the same period.

Lastly, you may experience a constant, changing dividend rate. Historically, distributions have been pretty consistent and growing but that may not always be the case in an extreme market downturn. Distributions can shrink at any time, and the fund may stop paying out those special year-end dividends at any moment.

Takeaway

Columbia Seligman Premium Technology Growth Fund stands out as a unique closed end fund with a focus within the technology sector. STK offers a unique blend of growth potential and income generation. Additionally, the fund's utilization of a covered call strategy allows it to achieve a dividend yield exceeding 6%, making it an appealing choice for income-focused investors.

The fund's ability to adapt its call-writing strategy based on market conditions, balancing between capitalizing on volatility and positioning for long-term growth, showcases the expertise of its management team. STK's cost efficiency further enhances its attractiveness, with a total annual expense ratio of 1.13%. For investors seeking income from the technology sector, STK offers a well-rounded solution to counter portfolio underweighting in this area.

Comparing STK to its competitors, such as ( JEPI ) or ( BST ), highlights STK's standout performance as a covered call fund. While competitors may offer higher dividend yields, STK's consistent price appreciation, NAV growth, and dividend growth set it apart, resulting in an impressive total return over time.

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