H&Q Life Science: Hold On, Its Time Is Coming

Back on October 23 BioHealth Investor [BHI] recommended H&Q Life Science (HQL) as a great biomedical closed-ended fund to invest in, rather than pick single risky stocks.

A few days later, the Alligator Investor made his case against HQL. Did he provide decent points of view? Not really. In fact, the Alligator agreed with BHI on many points, but cited that his intuition says that something is wrong with HQL. Basing your investment decisions on intuition alone is a form of gambling, but that is another argument for another time.

Well, on Thursday Jim Fink, writing for The Motley Fool, not only featured HQL as a great healthcare ETF, but chose it as the best ETF for 2007!

Mr.Fink's article goes far and beyond BHI's in breaking down HQL and comparing it to both Biotech HOLDRs (BBH) and iShares Nasdaq Biotechnology (IBB).

He points out, just as BHI did, that HQL pays out a dividend of 8%, which both BBH and IBB do not. He also makes the argument that HQL is more diversified, with none of the top holdings taking up more than 5% of the total portfolio. HQL also outperformed both BBH and IBB, and is 7% undervalued as compared to its Net Asset Value [NAV].

For all those reasons HQL continues to look favorable, and is the only BHI stock pick that has not gained substantially. Its time is coming.

2007 looks to be very promising for the biotechnology industry, and what better way to invest in it than to choose the industry's best comprehensive exchange traded fund?

HQL 1-yr chart:

Comments

[WC Whiner:]

I gave you a 1, and you deserve it.

One, unlike your interlocutor AI, you fail to mention that a fixed payout can lead to return-of-capital. When a closed-end fund returns capital, that is no longer a "dividend". You're just getting your own money back. You don't pay tax on it (nor should you -- imagine paying ordinary income tax on every bank withdrawal). All it does is reduce the fund's assets under management, as it is forced to sell holdings to return capital to investors. This is not, normally, a good thing. However, though I am almost loathe to note it, fixed-payout policies can have one salutary effect. Braindead yield buyers have a nasty tendency to start investing in them as if they were bonds whose "yield" were an actual coupon. The result can be rather preposterous premiums to NAV (cf CRF). A cynic might buy into any closed-end fund trading at a discount with a fixed-payout policy and hope that a few among them fall prey to this affliction.

Two, you do not mention fees. HQL charges 167 bps, vs BBH's 70 and IBB's 50 bps.

Now, I *like* HQL and its sister fund, HQH. At times I have used them for exposure, especially when they had double-digit discounts and I felt biotechs were unloved an potentially due for runs. I can even see investing in the hopes of being bailed out by the braindead yield constituency. However, to recommend them as serious investment vehicles over their alternatives without mentioning fees or the phrase "return of capital" strikes me as irresponsible, at best.

2006 Nov 17 01:47 AM

[hisham ayoub:]

Well, I appreciate your criticism, even though your tone has room for improvement.

I agree, the return-of-capital HQL pays should have been mentioned when speaking of the divident. That is one point I failed to mention. I also failed to mention the fees. Again, I agree with you.

However, the bottom line is very simple, HQL outperformed both the BBH and IBB by a wide margin as Mr.Fink mentioned on Motley Fool. That is it. That is what counts. It did not beat them by a small margin so as to not make a difference after tax deductions. It beat them by a wide margin.

Second, BBH and IBB do not accurately represent the biotech industry in my opinion. I am not saying HQL carries more stocks, but its diversification into the many sub-industry groups, and the fact it holds private companies gives small investors a vehicle that normally is not available.

2006 Nov 17 10:33 AM

[Panskeptic:]

"2007 looks to be very promising for the biotechnology industry."

Who has it been making promises to? A lot of smart guys find the stock market exceptionally vulnerable, and if the market does tank, biotech will help lead the way down.

Can we describe the quoted sentence as vaporware?

2006 Nov 17 03:36 AM

[hisham ayoub:]

If the market does tank then no sector is immune.

So I do not know where to begin criticizing your comment that if the market tanks, biotechs will tank, and thus, should not invest in them. Going by your comment then, we should not invest in any stocks.

But if you are picking on biotechs, then what makes you think biotechs will especially lead the way down?

2007 does look promising for biotechs, and medical tech stocks in general. and here is why I think so:

- biotech have not performed very well for most of 2006.
- just recently, over the last couple of months, little biotechs are being acquired by larger biotechs and pharmas like crazy. What does that tell you? If biotechs were expected to lose out in 2007 then wouldn't the buyers wait for a better deal?
- changing political landscape looks bad for large pharmas, but little biotechs will be the beneficiaries of lower constraints, ie. stem cell research, genetic engineering... That is why large pharmas are buying biotechs with pipelines now.


"A lot of smar guys find the stock market exceptionally vulnerable"

yeah, they always do, and half of the time they are correct, the other half...

you get the point.

2006 Nov 17 10:39 AM

[testguy:]

hisham, I like your comments. Amusing and quite insightful. I'm considering HQL as some kind of good theme investing choice besides PHO/PBW.....

2006 Nov 17 11:49 AM

[Chamois16:]

HQL may or not be a good investment in the future; it has been a very poor one this past year. I haven't heard or read any credible, persuasive rationale for why biotech or healthcare will, on a net basis, dramatically improve as a profitable business; there will be technological winners and losers, particularly in HQL, which is sort of a VC endeavor with more risk. Increased emphasis on R&D, as is often alleged, is apt to be offset by proposed reductions in patent protection and allowable prices charged, plus increases in corporate taxes. The net consequence is a great unknown.

More importantly, the Fink article fuzzes some issues of importance. The 8% yield is lauded, for example, even when it comes totally at the expense of capital appreciation. Iow, the fund must sell its winners to pay the distribution with proceeds from realized capital gains. If there is to be a resurgence in biotech and the investor wants to take full measure of that growth, truncating it for taxable current "income" doesn't make a lot of sense. Far better would be a fund which allows the winners to appreciate unharvested, at the expense of much lower payouts.

CEF like HQL cater to income oriented investors who, as has been mentioned earlier, subordinate total return opportunity to currrent gratification or need. This is particularly true on an after tax basis. They need to be valued in that context

2006 Nov 17 07:15 PM