THQ - HQL: Hold Your Investments In This Healthcare CEF For Strong Steady Yield

2023-09-27 14:34:01 ET

Summary

• Tekla Life Sciences Investors invests primarily in biotechnology stocks, and 10-12 large-cap biotech stocks (50% of total holdings) sets the trend and price direction for this fund.
• Poor price growth of biotech stocks thus has resulted in a huge price loss for this fund. However, the HQL closed-end fund has delivered consistent strong yields over the years.
• Despite poor price growth, I am bullish about the biotech sector due to aging demographics, adoption of new medical products, and robust M&A activities.
• HQL’s existing investors should enjoy such strong yield and wait for some sizable price growth in order to sell out their stakes at an opportune moment.

~ by Snehasish Chaudhuri, MBA (Finance).

Tekla Life Sciences Investors ( HQL ) is a closed-ended equity mutual fund, or CEF, that invests in growth stocks of companies. The fund offers strong and steady yield to its investors by investing primarily in life sciences and related companies (including healthcare, agriculture and environmental management firms). All its major investments are in large-cap biotechnology stocks.

The fund was formed on February 20, 1992, and has been paying strong and steady quarterly dividends since 2000. The fund has an asset base of $402.89 million, together with an extremely high expense ratio of 1.66 percent. HQL has a turnover ratio of 42 percent. The fund is currently trading at a weighted average P/E of 12.54x and a discount of 18.6 percent from its net asset value.

Being Bullish About Biotech, I Expect HQL To Generate Price Growth Over The Long-Run

Tekla Life Sciences Investors benchmarks the performance of its portfolio against the NASDAQ Biotech Index and the S&P 500 Index (SP500). HQL employs fundamental analysis with a focus on management’s experience, products or services of the companies, technological expertise, and the ability to generate funds internally to finance growth or to secure external sources of finance. The fund is known for its consistency in generating strong yield. Around 75 percent of its portfolio is invested in biotechnology stocks, while another 14 percent is invested in pharmaceutical companies. Thus, poor price growth of biotechnology stocks has resulted in huge price loss for this fund. Having said that, I have always remained bullish about the long-term prospect of HQL.

During February, 2022, being bullish about the long term growth prospects of the biotechnology sector, I assigned a decision on Tekla Life Sciences Investors. I opined that:

“ongoing pandemic/endemic, aging demographics and adoption of new medical products and services will surely generate long-term growth for healthcare companies. In addition, the commercial and late-stage biotechnology product pipeline of its major holdings could lead to significant increases in biotechnology sales. Investment opportunities also increase in such sectors due to robust M&A activity in the healthcare segment.”

I also mentioned that due to the long-term positive outlook of the biotechnology sector, that was the right time to invest in HQL, as it was trading at a discount.

Poor Price Growth Of Large-Cap Biotech Stocks Resulted In Huge Price Loss For HQL

Tekla Life Sciences Investors has consistently invested half of its entire assets in 10 to 12 large-cap biotechnology stocks. Currently, this list includes: Amgen Inc. ( AMGN ), Gilead Sciences, Inc. ( GILD ), Vertex Pharmaceuticals Inc. ( VRTX ), Regeneron Pharmaceuticals, Inc. ( REGN ), Horizon Therapeutics plc. ( HZNP ), Moderna ( MRNA ), Illumina, Inc. ( ILMN ), Seagen Inc. ( SGEN ), Alnylam Pharmaceuticals, Inc. ( ALNY ), Biogen Inc. ( BIIB ) BioMarin Pharmaceutical Inc. ( BMRN ) and BioNTech SE ( BNTX ). The list has remained almost the same over the past 7 quarters, since the time I began covering this healthcare fund.

Unfortunately, only three of these stocks (VRTX, SGEN, and REGN) posted price growth higher than 3 percent. Accordingly, HQL’s price fell by almost 14 percent. This may be disheartening, but this fund is not known for its price growth. HQL witnessed a price loss of 7.5 percent, 28.5 percent, and 39.5 percent over the past 1 year, 3 years, and 5 years, respectively. Despite such huge price losses, total returns were mostly positive due to its steady high yield.

Strong Yield & Poor Price Growth Implies HQL Is For Income-Seeking Investors Only

Annual average yield over the past 8 years has been more than 10 percent, and the yield never went below 8 percent. That's how Tekla Life Sciences Investors has catered to its investors, despite such a poor price performance. This clearly suggests that HQL is meant for income-seeking investors only.

During my last coverage of Tekla Life Sciences Investors more than a year back, I was quite bullish and commented that despite significant price loss during the short run and marginal price drop over the medium term, the strong and steady dividend payment could keep HQL’s shareholders interested for the long term. Considering the poor market growth due to the Covid-19 pandemic and the negative performance of large-cap biotechnology stocks between May 2021 and April 2022, HQL’s total return in some way implied a wise selection of its portfolio. I did not expect shareholders to liquidate their stakes in HQL due to the assumption that return will become positive somewhere in the future, and until that time they could enjoy HQL’s close to double-digit yield.

Tekla Capital Management-Operated Healthcare Funds Generate Quite Strong Yield

Besides Tekla Life Sciences Investors, Tekla Capital Management operates three more closed-ended mutual funds in the healthcare sector - Tekla Healthcare Opportunities Fund ( THQ ), Tekla Healthcare Investors ( HQH ) and Tekla World Healthcare Fund ( THW ). None of these funds has been able to generate positive price growth over the past five years. This implies how bad the healthcare sector has performed during that period. Unfortunately, HQL, with a 39 percent price loss, has been the worst performer among all of them.

However, the good news is that during the current year, HQL recorded the least year-to-date ((YTD)) price loss. Another positive factor is the consistent high yield recorded by all these Tekla funds. However, this comparative analysis doesn’t make much sense, unless Tekla Life Sciences Investors continues to generate such strong yield and someday the biotechnology sector reverses the trend and enters into a bullish run for a significantly long period of time.

Investment Thesis

Tekla Capital Management operates various healthcare funds, which offer strong yields on a consistent basis. Unfortunately, none of them has been able to generate positive price growth over the past five years. This implies how poorly the healthcare sector has performed during that period. But, despite poor price performance of stocks from the biotechnology sector, I have always remained bullish about this sector. I strongly believe that aging demographics, adoption of new medical products and services, and robust M&A activity will surely generate long-term growth for healthcare companies.

Tekla Life Sciences Investors invests primarily in biotechnology stocks, and 10-12 large-cap biotech stocks sets the trend and direction of price growth for this fund. Poor price growth of biotech stocks thus has resulted in a huge price loss for this fund. Historically, this fund has delivered consistent strong yield over the years, despite huge price loss.

I have repeatedly mentioned in my earlier coverages that existing investors of HQL should enjoy such strong yield and wait for some considerable price growth in order to sell out their stakes. Average P/E of 12.54x and a discount of 18.6 percent also supports that this is not the right time to sell this fund. Thus, I’d assign a hold rating to Tekla Life Sciences Investors.

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