THQ - One Of The Best Investments For The Next Decade: THQ And THW

2023-04-17 07:35:00 ET

Summary

• The Healthcare sector has outperformed in the last 10 years.
• Over the next decade, spending will skyrocket due to a rapidly aging global population, increased life expectancy, and significant medical breakthroughs.
• We take a look at two great CEFs that provide immediate and diversified exposure to this sector: THQ and THW.
• While both CEFs are great options, one is better than the other.
• Investing in healthcare is set to be one of the best investments for the next decade.

Co-authored with PendragonY

One good place to start looking for investments that will do well in the long term is to identify sectors that have outperformed the general market over the last 10 years. As shown in the graph below, the healthcare sector has outperformed the S&P 500 by around 90 basis points a year on average.

The aging of the world and the U.S. population will require more healthcare spending, which should cause this sector to do well over the next decade.

Here we can see the growth of those who are over 65. Right now, that population totals just over 55 million, or about 17% of the population. In the next decade, that will increase by more than 20 million to over 20% of the population. By 2050, the number of over-65 in the U.S. will grow to nearly 90 million or just under 23% of the population. They will need a lot of healthcare, particularly pharmaceuticals and medical equipment. This growing need will generate plenty of profits for investors.

COVID also revealed some underinvestment in healthcare, particularly in pharmaceuticals and medical equipment. Several developed countries have populations that are aging so fast that the populations are even likely to decline in the coming years. They will need to spend significant amounts of money to keep their aging populations growing and stop or slow this decline. So we will want to search for an investment that has exposure to those areas while having a lower exposure to healthcare providers and their labor issues.

Tekla Capital Management offers several funds that invest in the healthcare sector. In particular, it offers two funds that have the added advantage of paying a monthly distribution. Let's compare them and see which one makes for the better income investment.

Pick #1: THQ - Yield 6.9%

Tekla Healthcare Opportunities Fund ( THQ ) is a Closed-End Fund ('CEF') that invests in healthcare companies: pharmaceutical companies, healthcare providers, medical equipment companies, medical technology, and even real estate. THQ invests in companies that operate in the U.S. or get most of their revenue from US-based operations. If you see your doctor, you could be using one or more properties with a connection to THQ. Source

The healthcare sector is a defensive one since the demand for it is inelastic. One thing to note about THQ is that only about 25% of the portfolio is invested in healthcare providers. So if you are concerned about labor issues at hospitals and eldercare facilities, THQ only has limited exposure to those types of businesses.

The fundamentals for most businesses in this sector are strong and inevitable. The U.S. consumer is aging, and the demand for medical care is rising. Pharmaceuticals remain quite profitable, and nearly 30% of THQ's portfolio is invested in them.

Healthcare, in general, also remains resilient to economic conditions; you need them when you need them, not just when the economy is doing well.

We unquestionably want healthcare represented in our portfolio. The aging of the Baby Boomer generation puts higher demands on the healthcare system. This increasing demand makes for a great place to look for investments. The question is where to find yields in the range we want.

This is where the active management of a CEF can play a big role. The fund actively selects companies to invest in and uses leverage to boost both the gains it makes and the income it receives. Between the leverage and the realized gains, THQ can produce a distribution that meets our requirements.

Instead of large unrealized capital gains that can disappear like mist, we get a tangible monthly distribution deposited into our brokerage account - actual cash and not just numbers on a brokerage statement. THQ provides us with both competitive exposure to the healthcare sector and generous cash flow.

Looking at returns over the last five years, most of the time, THQ matches or exceeds the healthcare sector while providing superior cash flow.

Looking at the premium/discount to NAV, we can also see that the discount is now below the 5-year average. Furthermore, the discount has declined quite a bit in the last six months. This makes it a great time to buy THQ.

On your next doctor's visit, take a look around at all the things that are paying your dividends. The medication, equipment, and more are all generating earnings for the companies that THQ invests in. The income generated for you and THQ might not be enough to make you look forward to the visit, but it sure will make you feel a little better knowing that everything around you is generating some cash for you.

Pick #2: THW - Yield 9.8%

Tekla World Healthcare Fund ( THW ) is very similar to THQ but includes investments outside of the U.S. Source

THW owns an even larger percentage of pharmaceutical companies than THQ (39.4% versus 29.8%) and a small percentage of healthcare providers (16.2% versus 24.4%). The smaller percentage of healthcare providers in the company with investments outside the U.S. makes sense because fewer such entities are in private hands outside of the U.S.

Much like THQ, THW has the majority of its portfolio in the U.S., about 78.4%. However, 22.4% of the portfolio is made up of U.S. companies that have substantial revenue coming from sources outside of the U.S. The remainder of the top 10 regions are relatively rich countries in Europe and Asia.

Comparing the performance of the THW portfolio to the Morningstar Healthcare sector index shows that THW is lagging a bit. This is in part due to its exposure to international healthcare, which will do better if the dollar weakens.

Like THW, THQ also turns capital gains into cash flow. The higher distribution from THW tends to result in lower total returns because more cash is flowing out of the fund and into shareholders' pockets.

THW has paid the same monthly distribution of $0.1167 since the fund began in August 2015. The price is currently at a premium to NAV, which is being sustained by the larger yield. For investors who are looking to maximize current yield and are willing to sacrifice longer-term total returns for cash today, THW is an excellent high-yield way to gain exposure to the healthcare sector.

Which Fund is the Better Income Generator

There are several ways you can compare investing results between THQ and THW. You can make a fairly simple comparison by looking at yield. Since THW has a current yield of 9.8% and THQ has a yield of 6.9%, buying THW today will generate a larger income stream than buying THQ.

However, looking at the total return since the fund's inception, THQ beats THW. As an income investor, this is less important than generating sustainable income.

As income investors, we are looking to buy reliable streams of income. We also want these streams of income to keep up with inflation, so we recommend that investors reinvest at least 25% of the dividends from their investments. So how does an investment in each of the funds, THW and THQ, do when we take cash out equal to 75% of the income generated by THW? That works out to be $575 a month, which we will also adjust for inflation. The results are here .

As it turns out, even though the yield on THQ is lower, the market price grows faster than a similar investment in THW, taking out the same amount of cash each month.

For investors who are looking to take out the maximum yield right now, THW produces more. For investors who are reinvesting a significant portion and don't need a higher level of income right now, THQ will tend to outperform in the long run.

Conclusion

Each portfolio should have a good allocation to the healthcare sector. This sector is an excellent place to invest, even during times of uncertainty: Medical needs don't have cyclical or seasonal patterns. The industry's profits are not impacted by inflationary pressures, recessions, or bear markets. If history is any guide, this sector performs well during uncertain times. At High Dividend Opportunities, we have a good allocation to this sector as part of our "Model Portfolio," which currently yields +9%. This model portfolio is comprised of +45 dividend stocks and securities.

Importantly, with a rapidly aging population, longer life expectancy, and medical breakthroughs, this sector is poised to be one of the fastest growing in the coming decade.

We believe that having broad and diversified exposure to the sector is the best way to do it, rather than investing in individual companies. THQ and THW accomplish this by providing immediate diversification to the healthcare sector.

They are also great income funds for income investors. While THW has a higher yield, THQ has had a historically higher total return.

With this in mind, whether you choose to invest in the higher total return potential of THQ, or invest in the higher immediate yield of THW, investing in healthcare is set to be one of the best investments for the next decade!

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