- Two biotech healthcare and medical technology closed end funds have rights offerings for current shareholders.
- The rights offerings allow shareholders to increase their stake in the funds at a 5% discount to average market prices over the four days beginning June 19.
- Both funds have seen a sharp decline in market price relative to NAV since the offering was announced.
Investors in the two Tekla Capital Management closed-end funds, H&Q Healthcare Investors (NYSE:HQH) and H&Q Life Sciences Investors (NYSE:HQL) are considering the opportunity presented by the funds' rights offerings. These are intended to increase the net assets of the two funds by one-third. Shareholders (record date May 30, 2014) for each fund have been assigned one right for each share owned. Rights holders will be entitled to acquire one additional share for every three rights held. Rights must be exercised by June 23 at 5pm Eastern Time. My broker is requiring notification by close of business June 20. Others apparently have earlier deadlines of June 18 or 19, so individuals should check with their broker.
The subscription price is to be 95% of volume-weighted average share price on the NYSE for the four business days from June 20 through June 25.
The timing of the offering and the June 20 deadline from brokers gives investors the opportunity to assimilate a day of price information before committing to the offering. This will be followed by another three days of market activity before the final price is set.
I have written about HQH and HQL previously, and I refer the reader to those articles for my positive views of the funds. Both invest in biotechnology, including investments in private equity securities. Both invest in healthcare and medical technology. HQH restricts its holdings to these areas. HQL expands its portfolio to include broader life sciences biotechnology investments in fields such as agricultural and environmental biotech.
Last October I looked at several opportunities in the healthcare sector (see article here) as Obamacare was officially rolled out. At that time, HQH was priced at -3.73% discount to its NAV. I followed up two months later (see article here) by which time, HQH's price had moved to a premium of 1.76% for a 5% gain on discount compression alone. From that time through the announcement of the rights offering on May 19, the fund moved from premium to discount and back to premium again several times. Last month I summarized the rights offerings (article here).
Recent Price Movements.
Both HQH and HQL have had somewhat volatile premium/discount histories recently. Below are charts from cefconnect.com showing their behavior for the past six months. On these charts, the "May-14" label on the horizontal axis corresponds to the time of the first announcement of terms for the rights offering. The announcement that shareholders had approved the offering came a week earlier. Thus, the initial response to the offering and its terms was to drive up the premium for the funds.
Here is year to date price and NAV for the two funds. The dotted blue line indicates the date of announcement of the terms for the rights offering.
Note that both funds were trading near par for the period preceding the rights offering, each moved sharply up relative to its NAV as the terms were made clear. This was followed by an even sharper drop, which is where the funds stand at the time of this writing (mid-day June 18). Note further that these swings are uncharacteristic which suggests that they are being driven primarily by investors' opinions and reactions on the pending rights offering. The present discounts for each fund stand at about -6%.
Recent Price Movement Relative to Comps.
In previous articles I've compared HQH's price movements to that of iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), which the fund has tracked fairly closely on a total return basis. Note in the chart below (from Yahoo finance) that HQH's NAV (symbol = XHQHX, green line in the chart below) had done just that in recent days, but the fund's market price had risen at the time of the rights announcement then fallen relative to IBB.
HQH's three largest holdings are Gilead Sciences (NASDAQ:GILD) Regeneron Pharmaceuticals (NASDAQ:REGN) Celgene (NASDAQ:CELG). GILD has had a rough few weeks recently, but it and the other two holdings are outperforming HQH (market price). Again, this is not the case for HQH's NAV (green line in the chart).
Thus, it appears to me that there are no evident market events that would account for the declines in HQH and HQL's market prices other than investor concerns regarding the pending rights offering.
I have been long both HQH and HQL and have been very positive about both funds as a means of tracking the biotechnology space while providing income yields greater than 8%. (Note that both funds default to returning distributions as new shares, but the investor has the option to take them as cash.) It is my view that the funds are well managed and the biotechnology sector remains an attractive long-term investment. Again, I refer the reader to my previous articles for details.
It's my view that without the rights offering, the current discounts would make both funds attractive buys. My approach to CEFs is to buy as discounts drop to unusually low levels with the expectation that reversion to mean P/D status is likely. Normally, a sharp change toward an enhanced discount status, as seen in recent weeks here, would suggest to me that a buying opportunity may be imminent.
In HQH and HQL we have two funds trading at discount levels that have proven attractive in the past, coupled with the opportunity to buy them at an additional -5% from their most recent market prices. As I am pleased with my positions in the two funds, I find this a compelling argument for exercising the rights offering and increasing those positions by a third. I am near certain that I will do so. I will, of course, watch both funds' price movements on June 20 before I pull that trigger, but I fully expect to be notifying my broker on June 20 to exercise my rights to the fullest.
Nothing in this article should be taken as investment advice. I am an individual investor and this article represents a summary of some of my own research on how I will invest. Every individual's situation and priorities are of course unique, and will require individual consideration and due diligence.
Please feel free to offer any additional points of view or counter opinions in the comments. I (and the interested readers of this piece) will appreciate any and all points of view relative to this offering.