Evaluating CEFs: STK Still Growing NAV Despite Tech Sector Hit

Investment Thesis

This article will take a look at Columbia Seligman Premium Technology Growth Fund (STK). One thing that leaps out at me is that STK has done an excellent job of both covering its distribution and growing NAV. Even as the tech sector has taken a big hit so far in 2022. And the special distribution at the end of last year reinforces my determination that STK has a well-covered distribution.

What I look for in a CEF is a stable and reliable flow of income. I have developed a method of determining whether a specific CEF could provide a reliable stream of income. I developed my method after reading this article. Rather than the share price, it is my thinking that how the portfolio of the fund behaves and the income it generates are the determining factors in the reliability of the distribution.

I think it is a mistake to see a fund’s NAV as the sole component of the fund’s value. As an analogy, thinking of a fund’s NAV as the muscle that it uses to generate cash is a better way to look at NAV. So while it can be bad if the fund is eroding NAV (look at it as muscle atrophy), the fund’s ability to generate cash regularly is the true value. I look at a specific CEF and apply that method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I try to determine whether or not the fund will be able to support the distribution in the future. You can read an explanation of my method and get links to the other articles in the series here.

Columbia Seligman Premium Technology Growth Fund

Because I am looking for investments that pay out a steady cash flow, I start my evaluation by looking at the returns from a fund’s portfolio. So what kind of returns did STK get over the last 12 months?

So we can see the big drop since the end of last year (just over a month now), in both STK’s portfolio and the index for the technology sector (the Nasdaq-100 Technology sector index). But even with that pretty big drop, we see that the total return over the last 12 months was not only positive but hit 18.75% growth. This is both better than the index and better than a similar fund I have reviewed in the past, BlackRock Science and Technology Trust (BST).

But even with a total return of nearly 19%, if STK is over-paying its distribution that would still not be a good thing. So let’s next look at how the fund’s NAV did (which is the market value of its portfolio).

Not bad, STK’s NAV has increased 8.13% over the last year despite a big drop since the tail end of last year. That makes it much better than how a similar fund BST performed. And a very good sign that the distribution is fully covered. If NAV is increasing, almost always the distribution is covered. This is an even better sign for a fund like STK where most of the funding for the distribution comes from capital gains. So next, let’s look at the distributions over the last year and where the cash for them was obtained.

I see many very good signs for distribution coverage. The first is that the regular distribution was maintained for the year. In fact, the regular distribution has been maintained since the fund’s inception.

Next, I see that this year STK paid out a special year-end distribution. Special distributions are paid out only when the distribution is more than fully covered, and are paid because the regular distributions were not large enough to meet the statutory requirements.

The final good sign for distribution coverage was that none of the distributions over the last 12 months were designated as ROC. While ROC isn’t always destructive, it is better for long-term distribution support when no ROC is needed to provide cash to pay the distribution.

Between the 12 regular monthly distributions and the special year-end distribution, STK paid out $6.8369 in 2021. Based on an average NAV of $32.89, that is a yield on NAV of 20.8%. Using the peak NAV of $36.15, the yield on NAV is 18.9%. Both of these are above the total NAV return for the last 12 months. However, the total NAV return for the calendar year 2021 was 39.6%, which does exceed the calculated yield on NAV. With no ROC being paid, NAV increasing just over 8%, and the large special distribution, I am going to say that the distribution was still covered.

Long-Term Trends

2020, still pretty fresh in our minds, is a good example of why a single year might not be typical. So, while it is good that over the last year STK has covered its distribution, I want to be sure that is a fairly typical situation and not just because last year was a good one. I find that looking at a 3-year period is a good balance between enough data and having data reflecting recent performance. So how did STK do in managing its portfolio over the last 3 years?

I think it is safe to say that more than 120% total NAV return over 3 years or a CAGR of total NAV return of 30.15% is pretty good. However, while this does look good, even such impressive returns can be squandered if the fund is over-paying the distribution. So next, we want to look at how the NAV changed over the last 3 years and see if the fund was eroding NAV.

Well, there was no NAV erosion as it grew an average of 19.11% per year over the last 3 years. I note that the COVID crash and the recovery from it seem to have just returned STK’s NAV to its trend line. And that is a good thing, as the trend line was nicely positive.

Let’s look at how NAV has done over the last 10 years.

Looking at the 10-year NAV history, we can see that the fund struggled to grow NAV between 2012 and 2016. But after that, the trend has been towards growth. From time to time, the fund does get ahead of itself, but after a retrenchment, it again moves higher. An average growth rate of more than 5% for the NAV is very attractive to me as it shows the distributions have been well supported. This is even more important since much of the distribution has been paid from long-term capital gains.

Since STK’s inception in 2010, the regular quarterly distribution has been 46.25 cents. The occasional special distributions show that at times the fund has so over-earned its distribution that it had to pay out extra to remain in compliance. That is a good sign. The data convinces me that management is doing a good job managing the fund, providing a reliable distribution, and not over-paying the distribution. Exactly what I am looking for in a CEF.

Future Distribution Coverage

While it is great that a fund has covered its distribution in the past, it is that future distribution and whether it will be covered that is most important to me. And what a fund has done in the past is but a guide to help me predict that future. STK has done a good job at covering its distribution, so can I see any reason for that to stop?

STK is a tech fund and I see no red flags in its top 10. I expect to see somewhat slower growth in tech over the next 5 years or so. But I don’t see any significant problems. I expect the fund will see growth in NAV slower than the 19% it has had over the last 3 years, but still more than enough to fully support the distribution.

There are several metrics to use to determine if a fund is a good value. One is the premium (or discount) to NAV. Right now, STK is trading at just over a 4.3% premium. That is higher than the 10-year average premium of 1.13%. But it is also lower than the 5.22% premium it has traded at on average over the last 3 months.

Me, I look at the yield. For a tech fund that has a growing NAV, I am quite happy to get shares at a price that produces a yield of around 5.6%.

Conclusion

Tech stocks have taken a significant tumble since the start of the year. While they have started to recover, Meta Platforms’ (FB) recent results may slow this recovery. I think this offers an opportunity to invest in funds in the tech sector that are covering their distributions. STK is a fund that has covered its distribution well, and this price drop represents an opportunity that may soon go away.