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Introduced on April 2, 2014, Tekla Healthcare Opportunities Fund (NYSE:THQ) is a close-ended healthcare mutual fund launched and managed by Tekla Capital Management LLC. A close-ended mutual fund issues a fixed number of units/shares through an initial public offering (IPO) to raise capital, which it invests over securities or financial instruments of various organizations. These shares can then be bought and sold on a stock exchange but no new shares can be created, nor can existing shares be redeemed. In contrast, there is a constant flow of capital in an open-ended fund. Unlike open ended funds, where the fund manager has to fear outflows through redemption, lock in period in a close-ended fund provides the fund manager certain flexibility to create a portfolio with a long term growth potential.
With $907.84 million of assets under management (AUM), THQ is also a balanced fund. THQ invests in various corporate debt securities and equity shares of various healthcare companies spread across financial markets around the world. Within the healthcare sector, this mutual fund has adequately diversified its investments with 25 percent in pharmaceuticals, 20 percent in managed healthcare, 19 percent in healthcare equipment & Supplies, and 15 percent in biotechnology. Approximately 8 percent is invested in life sciences tools & services, and another 4.6 percent in medical devices. With 1.5 percent, Healthcare services has a very low proportion of investments. This is also a rare healthcare fund which has invested considerably (approximately 5 percent) in healthcare REITs.
Tekla Healthcare Opportunities Fund benchmarks its performance against the S&P 500 Index. THQ’s price grew by 27 percent and 29 percent over the past three and five years respectively. During the same time intervals, the S&P 500 has generated returns of 71 percent and 112 percent respectively. Although lagging behind the S&P500 in terms of price growth, considering the covid-19 pandemic related market crash during March 2020, this return is good. In fact, the healthcare sector has bounced back earlier than other sectors, and it again made significant losses in the past one year. However, unlike the recovery in 2020, the downward movement in 2021 was not spread across the length and breadth of the healthcare sector. More specifically, the large cap biotechnology, healthcare technology, and life sciences companies, had performed poorly, while pharmaceuticals and managed healthcare had a considerable flat growth. On the other hand, healthcare equipment & supplies , medical devices, and healthcare services had continued their growth momentum.
The price growth over the past five years is 5.2 percent CAGR. This price rise is complemented by an average dividend yield of 7 percent over the past four years and 7.5 percent over the past seven years. An average total return between 12 to 13 percent seems extremely lucrative, considering the fact that THQ pays monthly dividends, which is growing at a slow and steady rate. Dividend grew by almost 3 percent over the past three years.
Doubt may arise about the sustainability of such a return. Can THQ continue to deliver a yield between 7 percent to 7.5 percent despite investing in growth oriented large-cap healthcare stocks? THQ’s portfolio consists of 125 equity holdings, and 31 corporate bonds which generate fixed income. Top 70 percent of its investments are in 22 equity stocks of large-cap healthcare companies. Incidentally all these stocks overperformed the growth of THQ over the past five years.
Moderna Inc. (MRNA), for example, had a tremendous growth of 792 percent over the past five years. Another biotechnology giant, Horizon Therapeutics Public Limited Company (HZNP), and a managed healthcare firm, Molina Healthcare, Inc. (MOH), recorded a price growth of 640 percent, and 646 percent, respectively, during the same period. HZNP’ s price skyrocketed due to FDA’s approval of its rare disease drug, Tepezza just before the pandemic, for the treatment of patients with thyroid eye disease (TED). MOH, on the other hand, has benefited from its restructuring measures and membership growth.
Needless to say, these unique growth drivers are once in a lifetime events and may not be repeated anytime in the near future. So, I don’t expect these three stocks to generate similar growth in the next five years. However, these are the only three major holdings of THQ’s portfolio, which have shown extreme levels of volatility. Moreover, these three stocks constitute less than five percent of THQ’s portfolio. Around 65 percent of THQ’s portfolio have delivered strong and steady growth over the past five years. Another 13 percent is invested in corporate bonds, and 5 percent in short term investments. 14 percent of THQ’s investments are spread over another 103 stocks in very small proportion. This provides a very good balance and diversification to THQ’s portfolio, as these investments help to generate a steady fixed income on a monthly basis. Volatility of any of these 103 stocks are going to have negligible impact on THQ, as the average proportion of such investments is around 0.136 percent.
Barring those three stocks, THQ’s major investments (that constitutes 65 percent of its portfolio) have delivered relatively strong and steady growth, ranging from 31 percent of Bristol-Myers Squibb Company (BMY), a pharmaceutical giant, to 274 percent of Thermo Fisher Scientific Inc. (TMO). Besides TMO, six other stocks – Zoetis Inc (ZTS), IDEXX Laboratories, Inc. (IDXX), Eli Lilly and Company (LLY), Intuitive Surgical, Inc. (ISRG), Danaher Corporation (DHR), and UnitedHealth Group Incorporated (UNH) – have generated a growth in excess of 200 percent over the past five years. Another five stocks – Abbott Laboratories (ABT), AbbVie Inc. (ABBV), McKesson Corporation (MCK), Stryker Corporation (SYK), and Humana Inc. (HUM) – generated a return in excess of 100 percent over the same period.
The kind of growth stocks THQ has selected, the degree of diversification it has shown, and the level of balance the portfolio possess no doubt is impressive. Being a close ended mutual fund, the assets anyhow remain stable due to the specified lock-in period. Future growth prospects of this fund is dependent on the demand for healthcare products and services worldwide, which will anyway increase with time. The still ongoing pandemic/endemic, aging demographics and adoption of new medical products and services will generate long-term growth for healthcare companies in the medium and long run. In my opinion, long term investors can easily bet on this portfolio to generate a strong and steady return. Monthly dividend income makes this healthcare fund even more attractive.
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