BIGZ - Why BSTZ BMEZ And BIGZ Distribution Cuts Aren't A Big Deal

2023-10-04 09:55:34 ET

Summary

• BSTZ, BMEZ, and BIGZ have announced a change in distribution policy.
• The funds will now pay monthly distributions at an annual rate of 6% based on the 12-month rolling average daily net asset value.
• The new distribution policy will likely not have a significant effect on the funds' market prices, as they are already at significant discounts.

BlackRock Science and Technology Term Trust ( BSTZ ), BlackRock Health Sciences Term Trust ( BMEZ ) and BlackRock Innovation and Growth Term Trust ( BIGZ ) have announced a change to their distribution policy, which will effectively result in large cuts in distributions.

From the press release :

NEW YORK--(BUSINESS WIRE)--Each of BlackRock Science and Technology Term Trust (NYSE: BSTZ), BlackRock Health Sciences Term Trust (NYSE: BMEZ) and BlackRock Innovation and Growth Term Trust (NYSE: BIGZ) (each a "Fund," and collectively the "Funds") has announced changes to its distribution rate under its managed distribution plan ("Plan"). Each Fund has adopted a Plan to support a level distribution of income, capital gains and/or return of capital.

Effective with the distribution to be declared on October 2, 2023, each Fund will pay monthly distributions to shareholders at an annual rate of 6% of the Fund's 12-month rolling average daily net asset value to be calculated 5 business days prior to declaration date. For example, the October 2023 distribution will be calculated based on the average net asset value from September 23, 2022 to September 22, 2023. Each month this formula will be applied, and the distribution per share will be re-set and announced on the distribution declaration date.

Previously, like most other BlackRock CEFs, these three funds paid level distributions that would be reset infrequently based on market conditions or expectations. However, going forward BSTZ, BMEZ and BIGZ will instead pay a variable monthly distribution at a 6% rate, based on the past 12-month rolling average daily NAV. Given that BSTZ, BMEZ and BIGZ had paid NAV yields of over 9%, this change will effectively result in a significant cut when the new policy is implemented.

Is the new distribution policy good or bad? Actually, I don't think it has a very large effect either way.

First, let's remember that equity CEFs generally make use of capital gains and return of capital to fund their distributions (see Income Lab Ideas: Analyzing Equity CEF Distribution Sustainability ). When the stock prices of the companies in the CEFs' portfolios are rising, the funds can afford to pay out more distributions. In fact, BSTZ had actually increased its monthly distribution three times since inception, from $0.100/month to $0.192/month in just over two years, as growth stocks soared over the pandemic.

On the other hand, in a declining market the distributions will eventually have to be reduced to a more sustainable level in order to prevent the NAV from eroding too much. Whether this happens monthly with small decreases, or infrequently with larger cuts doesn't matter all that much.

Secondly, it should be remembered that return of capital is simply an accounting term (see Income Lab Ideas: Return Of Capital Isn't Always Bad ). While ideally we wouldn't want to see an overly high distribution resulting in an erosion of NAV (so-called "destructive ROC"), it should be remembered that any distribution, regardless of its classification, deducts from the NAV.

This is why I always encourage our members to not just focus on the yield! Ultimately, it is the funds' portfolios that drive the total return, not the percentage yield of the CEF or the tax character of the distributions.

Moreover, remember that any distribution, regardless of its classification, should be included in calculating the total return. With many CEFs, their share prices and distributions may have been declining over time due to an overly optimistic payout policy. However, if you include the effect of compound distributions, you would still get a very respectable total return.

Here is a simple illustration: Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund ( ETW ) has lost over half its NAV since inception in September 2005 (with distributions declining by -61.2%), but its total return on NAV is still a respectable +165.8% when distributions are included.

This is why the critiques that ROC is just "getting your own money back" are rather misplaced, though it is an understandable sentiment. Remember that as a shareholder, all of the CEF's assets are your money! No matter whether the distributions are coming from earnings, realized gains, or capital, it's still "your money" coming back to you.

Rather, the premium/discount valuation is more important in terms of thinking about generating alpha from CEFs. Consider the extreme case: if a fund is at a discount, I'd be very happy to get all my money back in a single liquidating distribution! This means that you'd be paying 90 cents to get a $1 back.

Finally, with the benefit of hindsight, timing was everything. BSTZ was the best performing CEF in all of 2020, and BMEZ also soundly thumped BME. Remember, the "Z" funds have a much greater allocation to more speculative companies, including private firms, which were bid up to excessive levels during the growth stock mania that reached its peak in early 2021.

Unfortunately, those who added or bought these funds at their high points would have seen major losses as the growth/innovative companies crashed. However, on a total return basis, we may have simply come back full circle. Since inception on BMEZ on January 29, 2020, BST (+27.52%) only slightly leads BSTZ (+25.72%). Although, the difference between BME (+25.04%) and BMEZ (+13.06%) is more significant, equating to around 3-4% performance differential per year.

Finally, I don't think that the market price of the funds would be affected too much once the first, lower distribution is announced, because the funds are already at significant discounts of around -20%.

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