THQ: Large-Cap Healthcare Stocks Performed Well This Past Year (NYSE:THQ)

Healthcare stocks had a poor year in the latter half of 2021, and in the beginning of 2022. I last covered Tekla Healthcare Opportunities Fund (NYSE:THQ) on 27th March, 2022. Since that time, the world has been experiencing economic uncertainty from rising interest rates, record-high inflation, increasing unemployment, and a fear of recession. All these have impacted the stock market in a massive way. THQ also recorded a price loss of 7 percent during those past six months, and the fund is available at a 9 percent discount to its net asset value (NAV). However, the past 1 month has been really good for this fund, as it grew in excess of 10 percent. On top of that, THQ is consistently paying a monthly dividend of $0.1125 for almost 100 months, and it generates an annual average yield of 6 to 7 percent. This makes this stock quite attractive, especially for income seeking investors.

Tekla Healthcare Opportunities Fund Invests in Large-Cap Healthcare Stocks

In my earlier coverage in March 2022, I advocated for long term investors to bet on THQ’s portfolio in order to generate a strong and steady return. I concluded that “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 are dependent on the demand for healthcare products and services worldwide…..and adoption of new medical products and services will generate long-term growth for healthcare companies in the medium and long run. Monthly dividend income makes this healthcare fund even more attractive.” Now, it’s time to assess whether those growth stocks have performed strong enough to keep investors interested in Tekla Healthcare Opportunities Fund.

More than 70 percent of THQ’s equity portfolio is invested only in 20 large-cap stocks from various segments of the healthcare industry. This list is dominated by large pharmaceuticals like Bristol-Myers Squibb Company (BMY), Pfizer Inc. (PFE), Johnson & Johnson (JNJ), Zoetis Inc. (ZTS), Eli Lilly and Co. (LLY), Merck & Co., Inc. (MRK); and healthcare equipment manufacturers such as Abbott Laboratories (ABT), Stryker Corporation (SYK), Medtronic plc (MDT), Becton, Dickinson and Company (BDX), and Boston Scientific Corp. (BSX). Tekla Healthcare Opportunities Fund made significant investments in biotechnology giants such as AbbVie Inc. (ABBV), Amgen Inc. (AMGN), and Humana Inc. (HUM). The list also includes life sciences tools & services companies Thermo Fisher Scientific Inc. (TMO), and Danaher Corp. (DHR); large-cap managed healthcare providers UnitedHealth Group Inc. (UNH), and Molina Healthcare, Inc. (MOH); healthcare services firm Cigna Corp. (CI); and healthcare distributor McKesson Corp. (MCK).

These stocks have been quite volatile during the past one year. But the good thing is, more stocks recorded high positive price growth than before. During the past 12 months, 10 out of these 20 stocks – MCK, CI, LLY, MRK, BMY, AMGN, HUM, MOH, UNH, ABBV – generated a positive growth between 20 to 80 percent. Whereas only 3 stocks – MDT, ABT, ZTS – recorded a negative growth in excess of 20 percent. It provides us a very clear picture of which healthcare segments have performed better during the past 12 months. Stocks from pharmaceuticals, biotechnology, managed healthcare, healthcare services and healthcare distributors performed well, whereas stocks of healthcare equipment manufacturers and life sciences tools & services companies had a poor year. Overall, the trend provides an optimistic outlook.

THQ Lags its Benchmark and Investors Need to Be Cautious While Investing

Tekla Healthcare Opportunities Fund has lagged behind its benchmark Health Care Select Sector SPDR (XLV). XLV generated a growth of 2.5 percent during the past 6 months. However, during the past 1 month, THQ outperformed XLV. A primary reason behind this variation is THQ’s exposure to bonds, and options. THQ sells call options to earn some extra income, which XLV doesn’t. However, by selling call options, THQ limits its capability to generate higher capital gains in a bull market. THQ is also paying out a substantial portion of its income or capital gains in the form of dividend, whereas XLV doesn’t. As this CEF pays out its gains, it fails to achieve the benefits of compounding.

Tekla Healthcare Opportunities Fund also has a very high expense ratio of 1.66 percent. This high expense ratio might have resulted from a high portfolio turnover of almost 58 percent, and use of leverage in its portfolio. Due to leverage, the multiple interest rate hikes have enhanced the interest expenses for this fund. However, a relatively moderate leverage ratio has kept things well under control. The overall market and macro-economic situation also need to be considered before making any investment decision. Barring the past one month, THQ has struggled this year. Thus, in my view investors need to be cautiously optimistic while investing in THQ, and I am not highly bullish about this stock either.

Investment Thesis

However, the healthcare industry, especially the large cap pharmaceutical, biotechnology and managed healthcare stocks are doing well and outperforming the market. More stocks in its top 70 percent equity portfolio have generated high positive price growth, than the number of stocks generating high negative price growth. The fund offers a steady pay-out with a reasonably strong yield. A steady monthly distribution is something that may attract investors under the current economic uncertainty. Healthcare, being a defensive sector, a CEF consisting of large-cap healthcare stocks and fixed income securities may fit the bill well for income seeking investors. But, due to some inherent risks, such as lagging behind its benchmark, high expense ratio, and use of options writing strategy, I’d prefer to hold back this stock, and wait for a higher discount in order to accumulate more units of Tekla Healthcare Opportunities Fund.

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