~ by Snehasish Chaudhuri, MBA (Finance)
BlackRock Health Sciences Trust II (NYSE:BMEZ) is a closed-ended management investment company with an operating history of less than 3 years. BMEZ is a sister fund of the BlackRock Science & Technology Trust II (BSTZ), and is struggling for more or less similar reasons - high yield that seems unsustainable, lack of diversification, and failure in generating price growth. The only difference is that BMEZ is fully focused on the biotech sector. As the biotech sector was tumbling, the fund is also feeling the heat. BMEZ's investment objectives are to provide total return and income through a combination of current income and long-term capital appreciation. Although it has been able to generate high yield during 2022, the average total return has been unimpressive. The interesting thing about this fund is that it is trading at an attractive discount of 16 percent from its net asset value (NAV).
BlackRock Health Sciences Trust II offers a monthly pay-out, thus dividends can be declared anytime. So, there is always a tendency for shareholders to hold these types of stocks. The fund is relatively new and so far, has generated high yield. It generated a yield of 10.43 percent in 2022. However, the pay-out comes entirely from capital gains. BMEZ's "next generation" healthcare holdings hardly generate strong pay-out. As underlying holdings do not pay sufficient amounts of dividends or interest, BMEZ doesn't provide actual net investment income. Through options, the fund could generate some gains. However, BMEZ has not been able to achieve significant income through this route. Considering the way biotechnology companies are taking a hit in equity markets, sustainability of such a high yield becomes doubtful.
Unless someone is familiar with the biotechnology industry, he/she might not recognize a good number of BMEZ's "next generation" healthcare holdings. Half of BMEZ's top 20 holdings include private investments and less known companies, such as Alcon Inc. (ALC), Imago BioSciences, Inc. (IMGO), AmerisourceBergen Corporation (ABC), Insulet Corporation (PODD), Waters Corporation (WAT), Mettler-Toledo International Inc. (MTD), Abiomed, Inc. (ABMD), DexCom, Inc. (DXCM), Halozyme Therapeutics, Inc. (HALO), and Penumbra, Inc. (PEN). As private investments are generally in smaller companies, this portfolio has high exposure to small-cap and mid-cap entities.
Top 20 holdings of BlackRock Health Sciences Trust II, along with its investments in BlackRock Liquidity Funds T-Fund Inst (TSTXX) accounts for 40 percent of its assets under management (AUM) of $2.1 billion. Among the well-known healthcare firms, Vertex Pharmaceuticals Incorporated (VRTX), Daiichi Sankyo Company, Limited (OTCPK:DSKYF), argenx SE (ARGX), ResMed Inc. (RMD), Alnylam Pharmaceuticals, Inc. (ALNY), Agilent Technologies, Inc. (A), Biomarin Pharmaceutical Inc. (BMRN), Sarepta Therapeutics, Inc. (SRPT), Neurocrine Biosciences, Inc. (NBIX), Qiagen N.V. (QGEN), Zoetis Inc. (ZTS), Alkermes plc (ALKS), and IQVIA Holdings Inc. (IQV) are also among the top investments of BlackRock Health Sciences Trust II. It'll be interesting to see how the two sets of stocks performed in equity markets.
During the past three months, all the relatively less known small biotech firms have delivered high positive price growth ranging between 8 percent to 40 percent. IMGO, a developer of innovative treatments for bone marrow cancer patients, has been proposed to be acquired for $36 per share, as a result of which its price shot up by 117 percent during the past 3 months. However, among the better-known biotech firms in which BMEZ has invested, stocks like VRTX, DSKYF, ARGX, RMD, ZTS, IQV, SRPT failed to generate growth beyond 8 percent. Thus, we can say that the "next generation" healthcare holdings have performed much better than the broader market, and thus work well for the BlackRock Liquidity T-Fund Inst. Price of BMEZ, during the same period, grew by 2.5 percent. S&P 500 delivered a return of 7 percent during these months.
Stocks like A, ALNY, QGEN, NBIX, ALKS and BMRN grew in excess of 9 percent to 21 percent. However, a close look at these biotech firms reveal that they are focusing or researching in some niche and need-focused segments, which makes these stocks quite interesting to track. Agilent (A) provides application focused solutions to diagnostics, life sciences, and applied chemicals. NBIX on the other hand discovers and develops drugs for neurological, endocrine, and psychiatric disorders. ALNY focuses on discovering, developing, and commercializing novel therapeutics based on ribonucleic acid interference (RNAI). QGEN offers sample to insight solutions that transform biological materials into molecular insights worldwide. BMRN discovers, develops and commercializes therapeutics for patients with serious and life-threatening rare diseases and medical conditions.
BlackRock Health Sciences Trust II generated a double-digit yield in 2022, and qualified for the minimum requirements with respect to AUM and stock price. The portfolio has a combination of relatively less known small-cap "next generation" healthcare holdings, and some familiar names in the field of healthcare biotechnology. However, the lack of diversification makes this fund susceptible to sector-specific risk. It also has a relatively high expense ratio of 1.3 percent despite the fund being non-diversified. This creates a doubt over the sustainability of the current level of yield.
Moreover, the annual average total return has been disappointing. The fund delivered negative returns of 6.1 percent and 32.6 percent during the past 2 years. During the past 3 months, the fund grew by 2.5 percent, much lower than the broader market (S&P 500). In absence of any price growth, the yield will neither be lucrative enough, nor be sustainable in the long run. I don't find BlackRock Health Sciences Trust II to be attractive according to my "7 Factor Model for Evaluating Equity Funds". The fund however is currently trading at a high discount to its NAV. Thus, at present, I would suggest a hold rather than a sell for investors of BlackRock Health Sciences Trust II.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.