BlackRock Science and Technology: Looming Losses

BlackRock Science and Technology Trust (New York Stock Exchange: BST) has fallen significantly in 2022. While the fund has had strong historical results, returning 14.25% per year since its inception in 2014, I don’t see this historical success continuing for two main reasons.

1. The Trust’s allocation leans relatively heavily towards fintech and semiconductors, with large positions in Visa (V), Mastercard (MA), Klarna (KLAR), ASML (ASML), Wolfspeed (WOLF) and Marvell ( MRVL). Both of these industries have been hit hard recently for a number of reasons, but both are particularly at risk from an impending recession scenario and rising interest rates.
2. Approximately 20% of the Trust’s net asset value is in preferred securities, primarily late-stage funding rounds. While not a threat in itself, the fact that 90% of these funding rounds occurred in late 2020 and 2021, venture capital funding spikeposes a threat to net asset value as private company valuations have recently seen declines, as evidenced by the huge 85% down from Klarna. Additionally, due to the above interest rate hikes, the IPOs of many of these investments will be significantly delayed due to the current market environment.

For the reasons stated and my belief that inflation and high interest rates (4-5%) are likely to remain for about two years, I rate BlackRock’s Science and Technology Thematic Fund a “Sell” rating.

Insight

BlackRock Science and Technology Trust is a perpetual closed-end (“CEF”) equity fund, which means it raises capital once during the initial public offering, and no new money will flow in, unlike a mutual fund. The Trust will invest at least 80% of its total assets in equity securities issued by U.S. and non-U.S. science and technology companies within any market capitalization range selected for their potential for rapid and sustainable growth through the development, advancement and the use of science or technology. Technology.

Assets

BST has a very technology-focused portfolio with 31.5% in software, 19.7% in semiconductors and 17.6% in IT services. Together, these three industries represent approximately 70% of the portfolio. The largest positions in the portfolio are Apple (AAPL), Microsoft (MSFT) and Tesla (TSLA).

NAV Premium/Discount

Open-end funds can trade at a premium or discount to their net asset value (the underlying value of the stocks they invest in). Most CEFs trade at a discount, as highlighted by research conducted by BlackRock from Q2 2022, indicating the median discount stands at ~7% over the past five years. While median discounts can be informative, CEFs have historically been observed to trade at an individual premium/discount, meaning that CEFs trading at a 10% discount have historically remained around this threshold. CEFs do not always trade at par with their net asset value and can be volatile overall, due to recent performance in net asset value, brand recognition or changes in attitude towards the investment theme . As of September 7, BST is trading at a premium of 1.64% which, given the reasons stated above, is a bit surprising as the discount tends to increase during market downturns. While this has been the case for BST, with NAV down 33.99% and market price down 40.01%, a slight premium remains. I think a discount will increase further throughout H2 2022, tending towards a relationship of par value with net asset value.

Rising interest rates and risky investments

As mentioned in my thesis above, I expect interest rate hikes to continue for the foreseeable future and to stay around 4% for about two years. I don’t pretend to be a macro mastermind who can predict when precisely the tipping point will be to halt rate hikes, as a plethora of factors influence that decision, including the future course of the Russian-Ukrainian price war energy as well as how supply chain constraints will continue to develop over the next 12 months. However, what can be said right now is that rate hikes will continue in the United States, and have only just begun in Europe, with the ECB announcing a 75bp rate hike basic today. As is known, this affects tech stocks the most as they have the highest growth estimates. While I’m confident this has been primarily valued for the common stocks held by the Trust, I don’t believe the same has happened to their venture capital investments at this time, with valuations potentially falling. collapse as it did for Klarna, a whopping 2% of the portfolio, which had to take an 85% drop and added liquidation preferences, favoring the most recent investor in the event of bankruptcy. Although it is not possible to rate every venture capital investment due to the unknown size and ownership of the notes, what can be said of their investments is that the notes that have been drafted date mostly from 2021 or the end of 2020, as indicated in the semestrial report. 2021 represents the peak of venture capital investment, with valuation having been at an all-time high. Investments in private markets, unlike investments in public markets, are not continuously evaluated. As these companies seek new funding due to the deteriorating IPO landscape, the declines will most likely continue to occur, and with that, the value of BST’s investments will likely decline even further.

Conclusion

BST has historically shown superior performance in a market environment with interest rates close to 0. However, market conditions have deteriorated, putting the Trust under fire, falling 40% over the past year. I don’t see any recovery for the underlying stocks and find it more likely that the net asset value will fall further before a true bottom is found. As mentioned a few times, the value of the Trust is strongly linked to the future evolution of interest rates and the ability of the fund to cushion the negative effects thanks to its options strategy.