Tekla Funds: In A World That Needs Healthcare, These Funds Have A Place In A Portfolio

Summary

• Healthcare offers essential services that people can't go without, recession or not.
• The Tekla funds can offer potential in any one of their funds for healthcare exposure.
• Today we explore the differences and the similarities of the funds.
• Looking for a portfolio of ideas like this one? Members of CEF/ETF Income Laboratory get exclusive access to our model portfolio. Learn More »

Photo by ipopba/iStock via Getty Images

Written by Nick Ackerman, co-produced by Stanford Chemist

Tekla offers investors four funds to choose from that are all involved in the healthcare space. There is Tekla World Healthcare Fund (THW), Tekla Healthcare Opportunities Fund (THQ), Tekla Life Sciences Investors (HQL) and Tekla Healthcare Investors (HQH). With a lack of really descriptive words in their title, one might not really know the nuances between these four funds. Today we are looking to break down each of these funds and see if they are compelling buys currently.

I will also admit, I'm a fan of healthcare overall. My most favorite sector or assets are utilities and REITs. However, healthcare comes to a close second. This is primarily due to the general stability that they can provide during recessions. It simply comes down to the fact that people need healthcare. Whether the economy is doing well or not. In 2020 we saw how resilient the space could be - excluding some subsectors that focus primarily on elective procedures.

(Source)

Tekla World Healthcare Fund

Starting out with THW. This fund has been in the news most recently. They have recently completed their rights offering. This met the fund with volatility that we often see with these events. At one time the fund looked like the offering could have been accretive due to trading at such a high premium. But alas, that wasn't the case as the fund plunged and the offering was slightly dilutive. Fortunately for current investors, they saw that it wasn't a good deal and they ended up offering 6,930,639 shares and raising less than $99 million. A good thing because the more investors that would have subscribed the more damage they would have inflicted on themselves in terms of dilution.

Data by YCharts

Now that it is settled and done, we can move on. The biggest difference for THW is that they have a "global" tilt. As their name would suggest - one of the few describing words in the titles. THW "invests at least 40% of AUM in ex-U.S. companies or those with substantial ex-U.S. revenues."

The fund utilizes leverage and last reported that at 21.20%. It is the highest yielding of the funds, but not by much at this time. This is also helping to drive its popularity coming in at 8.94%. It was over 9% briefly while the share price sunk. Rising back after the RO has been chipping away at the yield. The NAV distribution rate is still over 9%; however, at 9.11%.

The fund isn't at premium levels that it was previously, but it does remain at a slight premium of 1.89%.

Since launching in mid-2015, the fund has been able to maintain the same distribution rate. I certainly don't see the rate going anywhere either at this time.

(Source - CEFConnect)

The lack of a discount in THW makes it less compelling, even after it dropped quite significantly from its previous highs. If you are looking for a slightly better yield, it might be worth nibbling. However, I believe other Tekla funds offer a more appealing entry.

Tekla Healthcare Opportunities Fund

THQ is one of my longer-term holdings. I had held THW previously before it started trading at premium levels. That being said, THQ certainly isn't as cheap as it once was either. Reducing its discount to just 2.64% lately.

Data by YCharts

THQ is similar to THW, and they do overlap some. However, they don't have the global tilt that THW shows. Instead, they "invest across all healthcare sub-sectors and across a company's full capital structure." They mention full capital structure but the majority of the portfolio is in equity securities. As is the case with all the Tekla funds. THQ also utilizes leverage around a similar amount as THW. That came to 20.03% when they last reported.

THQ has the lowest yield of the group of Tekla funds. The distribution rate coming in at "just" 5.91%. On a NAV basis, this comes to 5.76%. Similar to THW, this fund hasn't adjusted its distribution either since its inception. Though its inception rate came almost a year earlier in mid-2014.

(Source - CEFConnect)

As of today, THQ does seem like a compelling buy with some discount, though not nearly as appealing as it once was. Still, if you are lacking healthcare in your portfolio I believe that starting at least an initial position in THQ could make sense. I still find THQ to be more appealing than THW if one is going to invest today.

THW and THQ

These funds can generally be grouped together. So I wanted to compare several points of these funds before heading onto HQH and HQL - which are similar to each other.

As touched on, the major difference between these two is THW is global and THQ has no focus on global.

Data by YCharts

Going back to THW's inception, THQ has been the clear winner. This is exactly what we would expect as the global securities market had underperformed relative to their U.S. counterparts. That being said, I have noticed that THW's portfolio has slowly been going more towards U.S.-based companies. With the qualifier that it fits into their policy by "those with substantial ex-U.S. revenues." It's a big world out there and several of the larger healthcare companies do have a "substantial" amount of revenue outside the U.S. That leaves them free to invest quite flexibly. This isn't necessarily a bad or a good thing, just need to be aware that with global in its name, doesn't necessarily mean you are getting that much global exposure.

For example, they last listed 53.9% in the U.S., with 17.2% considered "substantial ex-U.S. revenue."

(Source - THW Fact Sheet)

If we switch over to THQ, they don't list a geographic breakdown. Presumably, they are 100% invested in the U.S.

Data by YCharts

On a YTD performance, we see THQ once again still beating out THW. THW's share price attempted to outpace THQ's. Due to the rights offering as previously discussed, the fund took quite the hit. Which we were able to discuss back in January and avoid the losses altogether.

If we take a look at the top ten holdings of each, we will see where they start to overlap.

(Source - Fact Sheets)

Both holding solid companies to be quite sure, though noting that some of THW's differences come in the form of Roche Holding (OTCQX:RHHBY) (this trades OTC in the U.S.,) AstraZeneca (AZN) and Novartis (NVS), which represent the global allocation. Despite that, most investors will have heard of these names as they are large companies. THW and THQ both invest in mostly large-cap traditional healthcare names.

This is important because it is one of the key differences between their sister funds that we are going to cover. HQH and HQL invest heavily in biotech names. They can be more volatile.

Bonus fact: HQH and HQL are much older and were launched when Tekla was known as Hambrecht & Quist Capital Management, which, was bought out by JPMorgan (JPM) in 1999.

H&Q was originally an old investment bank that didn't focus just on healthcare. Instead, JPM bought it for the tech. From there, I wasn't able to find out how H&Q closed-end funds came out from under JPM, or if that part of the business was never acquired at all. There are just no sources.

HQL was launched in 1992 and HQH was launched in 1987.

Tekla Life Sciences Investors

This is one fund I've never really covered. Not because it is a terrible fund, but because HQH has tended to trade at a more attractive valuation. That being said, the current discount comes to 5.38% and is the widest discount of the four funds overall.

HQL primarily "invests in life sciences and other healthcare industries and will emphasize growing companies with a maximum of 40% of the Fund's assets in restricted securities of both public and private companies."

They mention that 40% can be invested in private companies. However, I have found that they don't typically invest that heavily in private companies, which would translate into level 3 securities. Their last annual report showed only around 6.6% in level 3 securities. Instead, the overwhelming majority of their portfolio is invested in publicly traded companies.

The fund has a varying distribution but the last one works out to a distribution rate of 8.57% for shareholders. On a NAV basis, it will float around an 8% distribution level.

(Source - CEFConnect)

This is because HQL and HQH have the same distribution policy of a managed 8% of NAV. It is calculated at 2% each quarter based on the NAV of the last distribution payment date.

As the fund with the widest discount, I find HQL quite attractive. Bearing in mind that its portfolio is dominated by biotech that can be more volatile. We will compare and contrast holdings more below as we did with THQ and THW above.

Tekla Healthcare Investors

Finally, we come to HQH. This fund is mostly similar to HQL. Their investment policy is this; "investing in healthcare industries with an emphasis on mid to large cap biotechnology and pharmaceutical growth companies with a maximum of 40% of the Fund's assets in restricted securities of both public and private companies."

They offer even slightly less exposure to private companies at only around 6.1% allocation to level 3 securities at the end of their last fiscal year.

While this fund traditionally carried the large discount between HQL and itself, the current discount comes to 4.09%. Both HQL and HQH's NAVs were hit pretty hard recently, which has led to the evaporation of their discounts primarily. Unfortunately, not due to their share price appreciation.

Invested similarly and with the same distribution policy, we see HQH's distribution chart varies as well - as expected.

(Source - CEFConnect)

HQL and HQH

One thing to note with both of these "twins" is that neither one of these funds uses any leverage. This can be beneficial as their underlying investments are volatile enough.

Here too, neither shows any breakdown for geographic exposure. Presumably, being invested in U.S. securities. We see some considerable overlap when we start to take a look at their top ten holdings.

(Source - Fact Sheets)

With this, it makes it quite hard to see the difference between the two. We have to take a look at the sub-sector allocations to start getting a better understanding.

(Source - Fact Sheets)

From here is where we can start to see a bit of a difference in the approach of the funds. HQL favoring a higher allocation to biotech at a nearly 10 point difference. Still, it hasn't resulted in a significant difference in terms of performance.

If we go back to the total returns since HQL's inception, we see that the funds follow each other quite closely.

Data by YCharts

On a YTD basis, we see HQH outperforming slightly. This is primarily due to the fact that biotech - being lumped in with the "growth" category - took a material hit this year.

Data by YCharts

Things were cooling down for the growth sector and we saw that play out in both of these funds. We touched on above, both funds' discounts are rather narrow relative to their historical range. Though it wasn't through share price appreciation, but rather NAV declines - which is what we don't regularly want to see!

Data by YCharts

As we can see from the chart below looking at the premium and discounts, the latest hit to NAV per share did reduce discount levels on both funds. This was by a fairly substantial amount too for both. We also see that HQH isn't the best value anymore. This was after the last several years of being just that.

Data by YCharts

Conclusion

To tie it together briefly:

• THW focuses mostly on large-cap traditional healthcare names with a small focus on global positions.
• THQ focuses mostly on large-cap traditional healthcare names based solely in the U.S.
• HQL focuses the heaviest exposure to biotech that can be more volatile.
• HQH also focuses on biotech but at a slightly reduced allocation relative to HQL.

In terms of what I see as attractive, I find HQL and THQ the most compelling and if I were adding today, it would be those two - keeping in mind that HQL's underlying holdings are more sub-sector specific and can add more volatility being in biotech. Although, do note that THQ's (and THW's) leverage will also increase their relative volatility levels as well. HQH and THW could easily be considered solid "Holds."

Healthcare overall is an essential service that can continue in good times or bad. Therefore, can be an essential part of an investor's portfolio. Utilizing the Tekla funds for such exposure can also be ideal for income investors as all four funds, while having varying yields, pay significantly more than what you can get from these individual names. Of course, that means they are paying out portions of distributions from income, capital gains and/or return of capital.

Analyst’s Disclosure: I am/we are long HQH, THQ, JPM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article was originally published to members of the CEF/ETF Income Laboratory on April 19th, 2021.

Comments

[toromi]

Thanks for this article. I've held THQ for about a year now, and this is definitely the Tekla fund you want to own if your goal is to maximize total return. The five year returns clearly beat THW and blow away HQH. And THQ investors have gotten a better risk-adjusted return as well. See www.portfoliovisualizer.com/... .

[Nick Ackerman]

@toromi thank you for sharing! Of course, past returns don't predict what will happen in the future. I do see THQ as the more stable of the funds. HQH/HQL can blow numbers away when biotech is doing well - however, will lag otherwise. It will be a rough ride as well, as it typically is with biotech.

[toromi]

@Nick Ackerman Due to the volatility I see biotech as either something you trade, or something you hold with a *very* long time horizon. I prefer THQ's more balanced approach, which should serve investors well going forward. (Even though past results don't guarantee anything as you pointed out, the fact that the fund has a strong risk-adjusted return to date is a big plus.)

[Nick Ackerman]

@toromi that seems to be a reasonable approach. Thanks again!

[katmandu100]

EXCELLENT data and commentary.

[Nick Ackerman]

@katmandu100 thank you!

[jazznut]

BME is my core position in the sector, not counting "boring" small positions in BMY, PFE, and MRK for their dividend flows, and an occasional very short-term fling with LABU.

[Nick Ackerman]

@jazznut thanks for sharing! I hold MRK as well.

[fairplayphil]

as i prefer fixed income , it took a while to warm up to Tekla funds but kept hearing good things about them. got THW @$13 ,skipped the RO and am very happy with it. your write up just reinforces that it was a good move. thanks

[Nick Ackerman]

@fairplayphil glad to help! Thank you.

[Jcb331]

@fairplayphil not to belabor the point but if you would have opted for the R/O at $14.26 price you would be up 10% now on price and 4% on Nav + $.1167/share/month on additional shares. not criticizing skipping the R/O, it could have gone either way, but just stating the facts as i see them. maybe I'm missing something.

[Nick Ackerman]

@Jcb331 it really could have gone either way. I didn't include the chart in this article now I realize, but had you switched to THQ instead, during the RO, then swung back that would have been the best result. That was what we had been suggesting. Of course again, could have gone either way!

[alchemist11]

This analysis was much needed! Thanks!

[Nick Ackerman]

@alchemist11 thank you!

[Seatonmanagement]

Long THQ, h/t to you, Nick, sometime ago now. Satisfied.

[Nick Ackerman]

@Seatonmanagement excellent! Glad to help provide an idea that fit your situation. Thank you!

[tommys]

Thanks, Nick - it seems like the portfolio of THQ is similar to that of the XLV. If that's the case, still go with THQ?

[Nick Ackerman]

@tommys that could be, as it leans more in a traditional Healthcare approach. I'd still prefer THQ. Though XLV could be a great place to hide out to wait for volatility. Because at that time THQ should fall greater due to leverage and the discount widening!

[tommys]

@Nick Ackerman - I asked because I'm in XLV and HQH. I will keep an eye out for the opportunity to switch from XLV into THQ when the market gives me the opportunity!

[Nick Ackerman]

@tommys I think for me to shift would require all healthcare CEFs that I'm long to go to premium territory. At that time, I'd consider switching to the ETF myself.

[jasonjones]

Healthcare is my background so I favor these funds. I held held THQ for quite awhile but dumped it before the virus problem. It's a good fund for overall health care exposure since it also includes healthcare REITs, but I didnt like leverage. Conversely, THW has a heavy concentration in pharma thus it lagged because of the crazy opiate controversy but did well once it was over and includes nursing home REITs. Both use a small amount of options as well as leverage which I don't like.

I am long on BME. It has low costs, no leverage, and writes individual stock options. Fees are reasonable, pays monthly, and covers the big healthcare stocks. It doesn't have REITs which I prefer to chose myself ie., HTA, GMRE, and DOC. It's sponsored by a huge company that employs good stock pickers. Distributions aren't crazy high so they are well covered.

BMEZ does most things HQL and HQH does with broader coverage of the health care spectrum. I have never liked the weird distribution policies of HQH. BMEZ pays monthly, uses options, takes risk in small companies and private placements. Again the large company that runs it and reasonable distributions make it an ideal long term hold. I don't like that it's a limited duration fund but I expect it will be successful enough to convert to a permanent fund. It still has a discount so there's a psychological motivation to buy it.

Nothing wrong with TEKLA funds as long as you understand what you are buying. The only thing I would remotely buy now is BMEZ even that is pricey.

[Nick Ackerman]

@jasonjones thank you for taking the time to add this input!

[team Gabe]

@jasonjones BMEZ has about 10% exposure to China

[jasonjones]

@team Gabe Thanks! I didn't know that. China is no problem at all because the USA sent it's manufacturing there. We are a debtor nation to them. I figure most USA companies do business with them. My daughter does international logistics as a profession. She deals with Chinese companies daily. Me? I think the USA made a big mistake outsourcing.

[rsmab01]

Great comparison article about these 4 funds.

Having bought THW right after the announced RO, I was able to take advantage of “sticker shock”. I am still confused, however, by mavens like yourself stating that the RO ultimately was a bad deal. Having exercised the offering, I was able to purchase more shares at 14.262. I understand the dilutive effects, but THW has held above 15 since the RO completion. That doesn’t sound like a bad deal to me and for others who purchased through the RO

[Nick Ackerman]

@rsmab01 it was because just sidestepping the deal and investing elsewhere would have given a better result. Plus, of course, the dilution to the fund's NAV - that's bad for all investors in the fund.

[Jcb331]

@rsmab01 Same here. bought 600 more shares in the R/O @$14.26 giving me a total of 2240 shares. I'm currently up over 21% with a Yield on cost of 10.7%. sure, if you sold when it hit $17 and bought back at $15 that was also a good deal. the NAV was at $14.90 with a 13% premium before the R/O and is at $15.25 now with a 3% premium. not sure how it was dilutive.

[Nick Ackerman]

@Jcb331 an RO becomes dilutive when the shares are issued below NAV. One of the reasons that it wasn't hit as much as it could be, was because shareholders saved themselves and they didn't participate to the full extent possible.

That aside, I'm always glad to hear of investors making a profit and comfortable with how they're invested! Everyone has to do what is right for themselves. Thank you for sharing!

[rickevantodd]

Excellent article. Nice analysis of the 4 funds. I am long THQ, long-term and THW & HQH relatively recent purchases.

[Nick Ackerman]

@rickevantodd thank you for sharing! Good luck with your investments!

[milbank]

@Nick Ackerman, Like CHI which you discussed a few days ago. THW is another CEF I own (though not as long as CHI) that I is ideal for my purposes. Another "buy it and forget it" holding. A very generous, highly stable dividend paid out monthly. What's not to like?

[Nick Ackerman]

@milbank well said! Thank you for reading and taking the time to provide your input.

[Dennis O]

There are times when articles like this are needed just to make us feel good about our positions and this is one of those times. You authors on Seeking Alpha have helped so many investors realize their potential. You and others deserve a lot of credit. Don’t know how many times you all get a pat on the back but you all do a good service and is appreciated. Now get back to work before you get get a big head.

[Nick Ackerman]

@Dennis O thank you for the kind words! And the prod to get back to work! hah

[Eileen Dover]

Recently picked up THW when it dropped to 15.15. Liked the portfolio very much of top notch stocks. Like the yield as well. It was a better deal than THQ at the time.

[Nick Ackerman]

@Eileen Dover thank you for sharing! I don't see it as a bad fund, I just prefer THQ personally. At one time I did own THW as well. Wouldn't mind getting back in at the right time!

[WSLegend]

Long time holder at one time or another of all four Tekla Healthcare Funds.
All of them represent a great way to obtain yield from the growing healthcare sector.
One other piece of information, HQH and HQL pay quarterly and TWH and THQ pay Monthly.

[Nick Ackerman]

@WSLegend thank you for reading! I also appreciate the added input here, that can make a difference for some income investors in regards to their distribution frequency.

[sc21]

thanks the review. These are older well respected funds. How do you compare them to BME? In terms of total return BMW and THQ seem to be quite close although in the last year Thq seems to have led. Not sure if there have been any important leadership changes. Much appreciated. SC

[Nick Ackerman]

@sc21 thank you! They do have some similarities in holdings. However, THQ uses leverage and BME writes covered calls on a portion of its portfolio. I'm long BME as well, though would suspect THQ to outperform during market rallies.

[WSLegend]

@Nick Ackerman
BMEZ is more attractive to many than BME

[sc21]

@Nick Ackerman
Thanks your timely reply. Over the 3 and 5 year time frames the two funds have been close on total return. I originally bought BMEZ because of the pe holdings. Now I find that H and Q does the same thing. Seems to be a real toss up between the two funds. Historically H and Q has had a closer relationship to the industry but not sure how much that counts. Best SC

[bryan555]

Thanks for the analysis. Very useful, as it's easy to get confused by Tekla. I was first tipped to the premium/ discount disparity by Douglas Albo, a few months ago. So bought THQ. Then got into THW after its crash.

Personally, I like BMEZ better than the other two Tekla funds.

[Nick Ackerman]

@bryan555 thank you! I'm glad you enjoyed. Also glad you were able to sidestep the rights offering. Then take the opportunity to get back in after the decline. I hold BMEZ and BME, as well as THQ and HQH. They have some overlap, but do also have different strategies and some differences where I don't mind holding both.

[kingssc]

@Nick Ackerman Thank you for this article, Nick.
I hold a 50/50 allocation to THW (for pharma exposure and yield) and HQH (for biotech exposure).

Do you see any wisdom to adding THQ to this mix? Or is that a bit redundant?

[Nick Ackerman]

@kingssc I think THW and HQH are covering most of your healthcare exposure. That being said, I see THQ as a more stable fund and more appealing as it is trading at a larger discount. Though the difference at this time isn't significant.