Summary

BlackRock Health Sciences Trust (NYSE:BME) is a healthcare sector-specific closed-end fund, or CEF, that invests in a fairly diversified portfolio of common stocks in the healthcare sector.

It currently provides a reasonable yield of 6.3% plus an attractive discount of close to -8% (below NAV).

BME has a very decent long-term record of nearly 19 years, matching and even exceeding the performance of the S&P 500 (SP500). However, the recent near and midterm performance has been lackluster, which is in line with the healthcare sector.

Introduction:

BlackRock Health Sciences Trust is a closed-end fund that was incepted nearly 19 years ago in Mar. 2005. The fund seeks to invest in healthcare companies with strong pipelines and potential long-term growth opportunities. It has access to the full spectrum of healthcare sector opportunities and invests across pharmaceuticals, biotechnology, medical devices, and healthcare providers. The fund also sells (writes) call options on the underlying equity portfolio, potentially reducing the fund's volatility and generating additional income.

"BlackRock Health Sciences Trust's (the 'Trust') investment objective is to provide total return through a combination of current income, current gains, and long-term capital appreciation. The Trust seeks to achieve its investment objective by investing, under normal market conditions, at least 80% of its assets in equity securities of companies engaged in the health sciences and related industries and equity derivatives with exposure to the health sciences industry. The Trust utilizes an option writing (selling) strategy to enhance dividend yield."

Other salient features of this fund are as follows:

• The fund is focused on providing total returns to its shareholders that include regular and mid-to-high monthly distributions.
• The fund uses zero leverage, which is definitely an advantage during a high-interest rate regime.
• The fund has a reasonably good record of performance when we look at the long term. However, the more recent performance is downright negative. But that has been true with most healthcare funds. Since its inception nearly 19 years ago until Jun. 30, 2024, it has returned 11.60% annually on NAV (net asset values) basis, compared to 10.30% from the S&P 500. Also, the fund has returned 10.42%, 9.15%, 3.41%, and 9.71% for the 10, 5, 3, and 1-year periods, respectively, on the NAV basis. These results assume that all distributions were reinvested.
• The fund follows a "managed" distribution policy and pays a consistent amount monthly, which currently yields 6.30%.
• As per its mandate, the fund can invest globally, but 93% of the fund's assets are invested in healthcare securities based or listed in the U.S.
• BME is a sector-specific fund, so by nature, it is concentrated. However, it is invested in roughly 139 securities, and its top 10 represent over 48% of the total assets. Over 97% of the assets are invested in common stocks, out of which more than 54% are in the Pharma and Biotechnology segment, while 43% are invested in the Medical Instruments & Services segment. So, within the Healthcare sector, it is fairly diversified.
• As of Jul. 02, 2024, the fund under its management had roughly $611.4 million in net assets (as well as total assets).
• The fund is an actively managed fund and has an expense ratio of 1.07% (including 1% of the management fee) based on the total assets.
• As of Jul. 02, 2024, its distribution yield on the market price was 6.31% and 5.83% on the NAV.
• As of Jul. 02, 2024, BME's market price offered a discount of -7.69% to its NAV. However, on a 3-year average basis, it has traded at a smaller discount of -1.82% and nearly flat on a 5-year average basis.

Financial Outlook:

Let's look at the Fund's Financial health and performance. The most recent detailed report that is available to investors is the annual report for the period of Jan. 2023 – Dec. 31, 2023. However, the semi-annual report should be due any time now.

Net Investment Income:

The net investment income (or NII in short) is the net income that a fund earns from its investment in the form of dividends, distributions, and interests or derivatives like options, minus all the fund's expenses, including management fees, operating expenses, commissions, and interest on leverage. For equity-based funds, especially in high-growth sectors like technology, the NII is not very relevant. However, for fixed-income or bond funds, it is very relevant.

Here is what it looks like in terms of NII, Distributions, and Net Assets at the beginning and end of the statement period.

(All amounts are in US $ (except Shares Outstanding) for the 12-month period; negative amounts are shown inside parentheses, per the annual report, 12 months ending Dec.31, 2023. We also provide the data for the year 2022 for comparison.)

Table-1:

Distributions:

BME has provided the same amount of monthly distributions, at least since Oct. 2021. Its yield is a bit low compared to other closed-end funds in the healthcare industry. However, it does not mean that other funds have been earning their higher payouts; they may be returning the investor's own money. So, in a way, a 6.3% yield is manageable and good for the long-term health of the fund's NAV (net asset value). At the same time, it is high enough to appeal to many income investors.

So, is the distribution covered?

BME is an equity fund, so there is simply not enough NII (Net Investment Income). It has to meet the major part of distributions from realized capital gains.

Table-2: Distribution Data

Note: The distribution data for the year 2022 is taken from CEFConnect, as we could not get the information from BME's website.

We can observe from the above table that distribution sources can vary from year to year. We also observe that the fund paid a higher percentage of distribution as ROC in 2023. Furthermore, we know that the healthcare sector has performed quite poorly since late 2022, so we have to see things from the long-term perspective. Also, the sector is showing signs of recovery right now. What we need to know is if the fund can maintain or grow its NAV over time. In the case of BME, it has. In fact, it started with an inception NAV of roughly $24, and currently, its NAV stands at $44, while it has paid over $51 in distributions over the years.

Discount/Premium:

The fund is currently trading discounted to -7.69% of its NAV. But if you look at its 3-year history, it has traded at a discount of -1.82% on average. On a five-year basis, the discount has been nearly flat at -0.25%.

If we look at the 5-year chart below, until early to mid-2023, it was mostly trading at a premium. However, since then, it has opened up a decent amount of discount. All that said, we should always look at both the premium/discount and the overall valuation of the fund within its sector. Currently, generally, stocks are expensive, but that is generally not true with the healthcare sector.

Chart-1: BME – Premium/Discount Chart

Funds Holdings:

The fund is sector-specific and fairly diversified within the sector. It is spread across all segments of the healthcare sector, such as Biotechnology and Life-sciences, Medical Instruments, Pharma, and Service providers. As of Dec. 31, 2023, it had nearly 102 equity positions plus some preferred and derivative securities. As of May 31, 2024, it has overwritten nearly 35% of the portfolio value via call options.

The top 10 holdings, which are mostly equity positions, make up over 48% of the total assets. Some of the top holdings are Eli Lilly and Co. (LLY), UnitedHealth Group (UNH), AbbVie (ABBV), Boston Scientific (BSX), Merck (MRK), Amgen (AMGN), Abbott Laboratories (ABT), Danaher Corp. (DHR), and Intuitive Surgical (ISRG).

The top holdings and asset composition as of May 31, 2024, are presented below.

Table-3: Holdings as of 05/31/2024

Table-4: Industry Segment Allocation (as of Dec. 31, 2023)

Table-4B: Geographic Allocation

Performance and Valuation:

The long-term performance, especially since inception, has been solid. Over the past 19 years, it has even exceeded the performance of the S&P 500, despite lagging by a wide margin in the last three years. The yield is not exceptionally high for a CEF but decent enough at 6.3%. The mediocre amount of distributions has been helpful to the fund through thick and thin, and it has been able to increase its NAV significantly over the years. The discount to NAV is also attractive on a relative and historical basis. So, we feel that the fund is attractively priced at current levels.

Chart-2A: Growth of $10,000 over the last 10 years

Table-2B: Annual Returns over 10, 5, and 1 year.

Let's see how the fund compares over the last 20, 10, 5, and 3 years with the S&P 500 and a host of other similar funds or healthcare ETFs.

• BME
• abrdn Healthcare Investors (HQH)
• Health Care Select Sector SPDR Fund ETF (XLV)
• iShares U.S. Healthcare ETF (IYH)
• SPDR S&P 500 ETF Trust (SPY).

Table-5: (Data - period as specified, if not specified then as of Jun.30, 2024)

Note: Some of the data (e.g., number of holdings and leverage) may not be current as of June 30, 2024.

In the above table, we have included the S&P 500 simply as a reference point; otherwise, it is not a benchmark for BME. However, we can see that BME has lagged the healthcare ETF XLV in the past 3–5 years. However, please keep in mind that BME uses call-options, while XLV does not. By using call-options, it does help reduce the volatility and generate additional income, but it also caps the upside of the overwritten securities. So, BME and XLV (or IYH) would not be an apple-to-apple comparison.

We would like to add that XLV is a solid healthcare ETF and is an excellent alternative for healthcare, except that it pays a very low yield, barely above the S&P 500. For this reason, XLV will not suit income investors. From an income perspective and similar total returns, BME fits the bill for income investors. Moreover, when a closed-end fund like BME is in a down cycle, the discounts tend to get larger, which is precisely the case right now. When the cycle turns positive, and NAV starts improving, the discount should start getting narrower. However, investors will need patience for this to play out.

Risk Factors:

Investors need to be aware of certain risk factors that are associated with this fund and CEFs in general. Risk factors could be summarized as follows:

• BME is a healthcare sector-specific fund. Even though it is diversified within the sector, it cannot escape the headwinds if the entire sector is facing challenges.
• The general risks, such as the geopolitical situation.
• There is still a possibility of the occurrence of a recession in 2024 or 2025, though most market participants are expecting a shallow one if that happens.
• Market risks: The S&P 500 has been making new highs on the back of large technology stocks and the AI-fueled boom. The broader market certainly is expensive in many areas, especially due to some bubble-like actions with the AI (artificial intelligence) hype. Even though the healthcare sector is not directly related to these events and has underperformed the S&P 500 by a wide margin and is generally undervalued, a significant correction in the broader market will bring down all sectors with it.

Concluding Thoughts:

BlackRock Health Sciences Trust currently offers a decent discount of nearly -8% and a reasonable level of income, roughly at 6.3%. BME is a proxy for the healthcare sector, as it is diversified into all segments of the sector. For income investors who do not need very high income, it is an excellent choice for the long term, with predictable income and decent capital appreciation. The healthcare sector in general, and especially the biotech segment, is showing early signs of recovery (from a down cycle).

Patient investors can profit by playing BlackRock Health Sciences Trust right while being paid for waiting. It is best to accumulate it on a dollar-cost-average basis. For existing investors with full positions, it is a "hold."