BMEZ Funds: Buy Low, Hold for Distribution and Rebound (NYSE: BMEZ)

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Written by Nick Ackerman, co-produced by Stanford Chemist

BlackRock Health Sciences Trust II (BMEZ) struggled to perform. This is despite its exposure to healthcare, as it invests more in healthcare innovation/growth. It also has private holdings which can also increase its level of risk. Losses have accelerated lately in its underlying holdings, but I consider it more attractively priced.

Over the past year, the fund has lost nearly 26% based on total net asset value return. Losses have accelerated dramatically even more recently, with the participation of broader markets.

In recent months, it was especially the innovation/technology space that was difficult. Below we can see the comparison between BMEZ and its predecessor, BlackRock Health Sciences Trust (BME). BME holds the most traditional healthcare names. We can see how much better BME held up compared to BMEZ. However, casualties still occurred there as well.

Performance of the BMEZ fund

Y-Charts

BMEZ’s discount has deepened and the overall drop could be a fairly attractive entry into this fund. That being said, it remains a riskier holding and not for conservative investors. After 2021’s poor performance, it won’t be the most encouraging investment either, meaning the discount could linger for a while. There weren’t many places forecasting losses in 2021, but BMEZ was one.

The basics

  • Z-score over 1 year: 0.85
  • Discount: 3.55%
  • Distribution yield: 8%
  • Expense ratio: 1.31%
  • Leverage: N/A
  • Assets under management: $2.511 billion
  • Structure: Temporary (early liquidation on January 29, 2032)

BMEZ “seeks to invest up to 25% in private companies”. It intends to do this through “at least 80% of its total assets in equity securities of companies primarily engaged in the health sciences and equity derivatives group of industries with exposure to the group of ‘health science industries’. Along with this, he also uses an options strategy.

It last reported that 21.92% of the wallet was crushed. This is below its target range of 30% to 40% and would indicate a bullish position. In hindsight, if they had been more aggressive in this strategy, it might have made up for the losses a bit more. At this point, it seems appropriate to keep the crush percentage lower, so that positions don’t get canceled on a bounce. Of course, that’s if there’s a rebound and how aggressive the rebound might be.

The fund has a term structure which will see the fund potentially liquidated around January 29, 2032. They can switch to a perpetual fund after a takeover bid for 100% of the outstanding shares at 100% of net asset value. If there are still $200 million in total net assets remaining, the board can transition to a perpetual structure. After this point, there will be no more support to hold the fund at its net asset value.

Even if the fund ended flat from here, at least the 8.43% discount could be reaped. It is unrealistic to believe that there will be no change in the price and net asset value of the fund over the next ten years. This is something that should continue to be monitored and can be taken advantage of closer to the fund’s termination date.

The term structure is designed to prevent the fund from trading at a perpetual discount. If the fund performs well, the fund would likely continue to operate. After the launch of the fund, he took important steps which certainly helped to give him a good start towards this goal.

Performance – Disappointing so far

The fund seemed to have a lot of potential in its early days. It was one of the best performing funds in 2020. Although CEFs are only a function of their underlying investments, they are a wrapper for investments and not an asset class themselves.

The inception date of January 29, 2020 has proven to be the perfect time to launch such a fund. The COVID pandemic hit and they were able to take advantage of lower prices to grow their portfolio. On top of that, we also know that the innovation space was exactly what worked in 2020.

Since then, the decline has been slow. 2021 generated a total return of -8.31% and a total net asset value return of -5.76%.

With losses accelerating in 2022, BMEZ wouldn’t necessarily look like a promising investment. However, I would say now is an even better time to invest. I don’t know when the sale will stop or if we are just getting started. What I do know is that the fund’s discount looks quite attractive and the sale has definitely made it much cheaper than it was before.

Launching in 2020 means we only have a few years of data to look back on. That said, we see that the fund’s discount is around its average. He came back quickly from the last drop. Still, the overall decline presents an attractive opportunity in itself.

BMEZ discount or premium at NAV
Data by YCharts

CEFs tend to outsell other investments due to their discount/premium mechanism. They are also mostly owned by retail investors, so they usually shoot first and ask questions later. This dries up buyers of these funds, which can fall significantly below their net asset value levels. For those of us who invest in CEFs, we generally see this as an opportunity to be exploited.

Distribution – 8% is attractive, but be careful

Although the fund has a pretty attractive valuation now – a higher payout ratio is attractive – I should be a bit gloomy here. It won’t be sustainable if we don’t start getting a rebound.

Currently, the payout ratio is 8%. Higher yields are great, but we start to encounter sustainability emitters the higher we go. The ANAV rate stands at 7.72%.

Last year we saw a small special fund distribution of $0.0621. This happened as they made many of the gains they carried over from 2021. It wasn’t a function of actually performing well in 2021; as discussed above, they produced losses for the year. This strong 2020 performance was exactly why we saw an increase in distribution in 2021 as well.

BMEZ covers its distribution with capital gains. It generates no net investment income. NII is simply total income minus expenses. Since the fund is focused on innovation and private companies, it doesn’t collect a lot of dividends or interest.

BMEZ distribution

BMEZ semi-annual report (Black rock)

Now that the gains are drying up, we could see a reduction in distribution. All that said, this will remain one of the only ways to keep getting paid until a bounce. The fund will eventually continue to pay out at least something due to the structure of the CEF.

BMEZ portfolio

The average market capitalization of the underlying investments in its portfolio is $21.724 million. The average market capitalization of BME’s underlying holdings is $167 million. It just shows that BMEZ invests in much smaller companies than BME. Small companies tend to be more risky, which is the case with BMEZ. This is what makes it a riskier CEF in the first place. Then we also have the private holdings of the fund.

At the end of the third quarter of 2021, most of their private investments were directed towards biotech stocks. No surprise, this is one of the worst areas in the market – which is why BMEZ performed so poorly.

Luckily for us, many of the private holdings BMEZ had invested in have now gone public. This means we can take a look at how some of them fared.

BMEZ Private Holdings

BMEZ Private Holdings (Black rock)

As of January 20, 2022, “pharma, biotechnology and life sciences” is the fund’s largest sector allocation. Which just repeats what we saw in his private assets.

BMEZ sector allocations

BMEZ sector allocations (Black rock)

One of the fund’s largest private holdings was Oak Street (OSH). This stock was a darling of 2020 when it went public. The IPO price was $21, and it quickly skyrocketed after its IPO. A sharp decline that began in August 2021 has sent stocks below that price back to under $18 now.

BMEZ Price Chart

Y-Charts

Let’s look at Kymera Therapeutics (KYMR). This was another pretty big investment for BMEZ in the biotech space. This stock went public in August 2020 at $20 per share. We again saw it open significantly higher. Then towards the end of 2020 it started to go parabolic. Since then, the stock has held above its IPO price, but has more than halved from its peak. Share price losses have accelerated in recent weeks.

Kymera Therapeutics share price

Y-Charts

Suffice it to say that many other charts are similar. Sigilon Therapeutics (SGTX), Annexon (ANNX), and Taysha Gene Therapies (TSHA) have all gone public at various times. SGTX has to be one of the worst, though; it is now a penny stock. ANNX and TSHA are heading in this direction.

Price SGTX vs ANNX vs TSHA

Y-Charts

Many of these stocks also seem difficult to recover. While BMEZ’s private investments make it more unique and interesting, it also shows how erratic, volatile and risky these things are.

BMEZ Top 10

BMEZ Top 10 (Black Rock)

Although to be fair, the private equity holdings that went public more recently in 2020 aren’t the only struggling stocks. The BMEZ top ten includes several names that have been around for years. Among the top five, only Alcon (ALC) has not been listed for more than 10 years. Here is an overview of the performance of the top 5 positions of BMEZ.

Price of BMEZ holdings

Y-Charts

It’s no surprise why BMEZ struggled with performances like this. Much of what the fund invests in is simply not performing. Positions that yield results for shareholders are relatively few in this fund. I believe some of the private holdings at this point are a lost cause; however, others here just seem to provide an attractive entry point. This is also what makes BMEZ more interesting.

Conclusion

BMEZ has been going through a difficult period since its first successes. These successes translated into a higher payout for shareholders. However, this allocation currently appears to be under pressure, with assets deflating rapidly for the fund. Most of the fund’s private and public holdings all have the same trajectory – that is, significantly higher than a rapid decline. The declines have gathered momentum as we head into 2022. It has rebounded strongly, and I don’t know if this is a reversal or if we will decline. However, I believe that if the higher risks can be managed here, it is a tempting offer that is served.

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