BST: A 9.6% Yield From Microsoft And Apple (NYSE:BST)

BlackRock Science and Technology Trust (NYSE:BST) is somewhat of a unique closed-end fund with its focus on tech stocks Apple (AAPL), Microsoft (MSFT) and Nvidia (NVDA). The portfolio is essentially an income play on the tech-heavy Nasdaq 100 (QQQ) and last declared a monthly distribution of $0.25 per share, in line with the prior distribution, and for an annualized 9.5% distribution rate, which can also be colloquially referred to as a yield.

What’s to like here? A near-double-digit yield paid monthly is always a strong pull for investors in the forever pursuit of income. However, a dichotomy becomes inherent when you look at the CEF’s largest positions.

Apple (AAPL) at 6.63% of BST has a 0.63% dividend yield, Microsoft (MSFT) at 6.55% of the CEF has a 1.10% dividend yield, and Mastercard (MA) at 3.46% has a 0.64% yield. So the larger yield of the CEF seems like a contradiction and more austere income investors would be right to flag this. BST drives its yield through long and short-term capital gains.

Critically, the CEF systematically liquidates its positions and pays out the proceeds to its shareholders. This differs from some other types of CEFs where the distribution rate is driven by common or preferred share dividends or bond coupon payments. Distributions from capital gains are at higher risk as they depend on positive stock performance to be maintained. This slightly runs counter to the rallying call for dividend investors; it’s the income that matters.

Capital Gains, Return of Capital, And The Future Of Tech

This call alludes to the need for dividend investors to ignore the noise of price movements versus their payouts and BST’s inverse of this is not necessarily a negative. Bulls would be right it adds crucial technology diversification to REIT or BDC heavy portfolios with these technology companies being set to be the pillars of creative destruction for the next decade and beyond.

However, tech stocks have been hit hard by the current rising Fed funds rate environment with the CEF down by 19% over the last 12 months on a total return basis. This is versus a 15% loss for the QQQ and a 6.15% loss for the S&P 500.

Zoom out over the last 3 years and the performance divergence is even starker with BST up 26.7% on a total return basis versus 44.25% for QQQ. The angst around the rising Fed funds rate has dominated the stock market and led to a broad waning of valuations multiples that moved to historic highs during the pandemic-induced retail trading boom.

This turbulent macro backdrop has forced the CEF to be more dependent on return of capital with the last $0.25 distribution being entirely constituted by ROC. Indeed, cumulative ROC for the last 12 distributions stands at $0.6023, or around 20% of total distributions of $3 over the same period. It’s not uncommon for unlevered equity CEFs to occasionally pay out distributions from ROC and the bulk of BST’s distributions have come from long-term capital gains.

Bulls will be hoping the recent ROC is a one-off and not the start of a longer-term trend as the higher the figure of ROC as a per cent of total distributions the greater the erosion of the CEF’s asset base. The CEF will have very limited value to its shareholders if the bulk of future distributions is from ROC. Further, with the CEF charging a gross expense ratio of 1.05%, higher than the 0.2% charged by QQQ, its holders will need an outperformance in excess of the tech-heavy Nasdaq which has simply not yet happened.

The Discount To NAV And Near-Term Outlook

To be clear, holders of BST are essentially paying 5x more fees to underperform the most comparable and inversely correlated ETF. They’re also being paid their own money back in the form of ROC and buying shares of BST at a premium to its NAV.

This has moved sharply higher from when it traded at a discount of nearly 8% just over a year ago. The desired near-term outlook for bulls would be for the current rate hike cycle to come to an end and for the Fed funds rates to stabilize at a not more than a 50 basis point increase to the upper limit from its current level. This should drive the next avenue of positive price performance for tech.

Hence, BST is essentially less of an income play and more of a play on the broader recovery of the tech sector vis a vis the end of the rise in Fed funds rates. Whilst the CEF does have a smaller position in unlisted private startups, the sizing of this has not been a material factor for overall returns. Fundamentally, it would be hard to rate behemoths like Apple and Microsoft as a sell and BST does stand to rebound more markedly once there is a dovish Fed pivot but its fees and comparatively poor performance also make it difficult to recommend as a buy. Hence, I’m neutral on the CEF.