Co-produced with “Hidden Opportunities”
Healthcare is a sector that very few understand. The science of diseases, illnesses, traumas, and disorders and the mechanics of drug action within the human body is far from an average individual’s standard set of academic learnings. Most of us can’t even pronounce the names of popular drugs of the global top 10 pharmaceutical companies.
For the average investor, the Healthcare sector can be fraught with risks. The majority of us cannot forecast the success of a biotechnology company’s drug pipeline. Truth be told, clinical trials are blind to everyone, including the company insiders. And a setback can erase millions (or billions) in market cap very quickly.
This industry comes with innovation at its finest – in pharma, biotech, medical devices, life sciences, and technology-enabled patient services. Advances are being made every single day.
According to PwC, this industry is also a hotbed for M&A activity, with deal volumes growing by 32% in 2020 and 65% in 2021. A basket of goodies for large investors, right? Let us look at what the billion-dollar hedge funds are doing to participate in this sector.
Billion Dollar Hedge Funds Are Hiring Medical Professionals
Steven Cohen’s Point72 Asset Management is actively recruiting healthcare professionals as analysts and is bullish with several picks in the space as part of their core portfolio.
UBS O’Connora $ 12 billion hedge fund, is expanding its healthcare-focused investment team by hiring three medical doctors.
They aren’t alone. Recently, Goldman Sachs Asset Management (‘GSAM’) formed a healthcare advisory council to provide expertise on the firm’s private equity strategies within Healthcare.
What Are The Billionaires Doing?
Ken Griffin, the billionaire hedge fund manager and the founder CEO of Citadel Investment Group, owns 85% of the securities of the global hedge fund. Toward the end of Q3 2021, ~ 12% of the billionaire’s portfolio consisted of healthcare stocks.
Billionaire David E. Shaw has a current portfolio with a significant 9.4% composition from the Healthcare sector, almost double from the previously analyzed period. The most notable names from the list include Moderna (MRNA) and Pfizer (PFE).
Why Healthcare Now?
Despite pharma and biotech research being all over the news for two years, and their research output proving vital during this COVID-19 global pandemic, Healthcare is among the economy’s cheapest sectors.
We will continue to see growing investments made globally to protect our economy and citizens from future pandemics and public health crises. A recent Deloitte report cited advancements in science, technology, and analytics as catalysts for the Healthcare industry’s clinical, financial, and operational transformation in 2022 and beyond.
There is another reason Healthcare is a fantastic sector to invest in today. The demand for health care and associated products and services is immune from inflationary pressures and economic conditions. Illness does not have bull and bear markets. Between 1935 and 2022, medical care experienced an average annual inflation rate of 4.66%. We have seen wars, recessions, geopolitical crises, presidential assassinations, and many other natural and human-made calamities in these 87 years. Yet the demand and cost of care continued moving upward, making this sector one with a historically high probability of beating inflation. (Source: Hartford Funds)
Billionaires are interested and bullish on Healthcare and are hiring experts to help with their portfolio design. What about individual investors? Do you want to pick individual stocks with minimal understanding of drug pipeline strength, patent expirations, clinical trial outcomes, changing regulations, and several other tough topics that govern this sector?
Diversification is critical when it comes to investing in Healthcare. Even Mr. Buffett advocated for it in the 90s.
“If we could buy a group of leading pharma companies at a below market multiple, we would do it in a second.” – Warren Buffett
How can we do that? We can gain instant diversified exposure within Healthcare with CEFs (Closed-End Funds). With CEFs, you have qualified experts working to assess and evaluate opportunities in this lucrative sector while collecting regular income. Importantly, you get instant diversity and broad exposure to a great sector, without significant exposure to the underperformance of one company. Without further ado, let us dive into these picks.
Pick # 1: HQH, Yield 9.3%
Tekla Capital Management is an asset manager that specializes in Healthcare investing. Their team consists of personnel who are qualified medical doctors and scientists with a strong background in fundamental research and portfolio management. In fact, Tekla prides itself on being healthcare investment managers, not investment managers that manage healthcare.
Tekla Healthcare Investors (HQH) was established in 1987 and is Tekla’s oldest CEF. HQH is well diversified into 148 securities, with a heavier emphasis on biotechnology (58%), followed by pharmaceuticals (16%) and Life Sciences (8%).
While Tekla CEFs appear similar in their strategy, HQH is more broadly diversified within Healthcare and has a relatively more significant focus on US-based commercial staged companies (companies that generate revenues and earnings). So you will mostly expect large-cap names in HQH, as seen from the CEF’s top 10 holdings.
HQH pays a variable quarterly distribution of 2% of the fund’s net assets. The CEF sometimes employs Return of Capital (‘ROC’) to pay the distributions.
For a fund like HQH that has done an excellent job preserving NAV over the years, this variable distribution policy and the ROC component do not necessarily pose a risk to your income, particularly when the CEF is purchased at discounted valuations. (Price vs. NAV source: cefconnect)
HQH’s $ 2.01 / share annual dividend (trailing 12 months) calculates to a 9.3% yield. Today, this CEF presents an attractive investment opportunity through its 4% discount on NAV. As an increasing number of hedge funds are building in-house expertise to better invest in Healthcare, we expect this sector to have an improved valuation multiple. As that happens, HQH’s valuation is also set to improve, and investors will be rewarded with higher distributions.
Pick # 2: THW, Yield 8.5%
Tekla World Healthcare Fund (THW) is HQH’s younger sister with salient differences in strategy. This CEF was established in 2015 and has greater exposure to pharmaceuticals, healthcare equipment & supplies, and healthcare providers & services companies. (Source: THW Fact Sheet)
THW has greater exposure to non-US companies and, unlike HQH, has about 14% exposure to convertible bonds and preferred equity of healthcare companies.
THW is well diversified across 158 holdings and employs modest leverage of 17%, and we can see health insurance, medical devices, healthcare services, and non-US names in its portfolio.
THW has a policy to distribute $ 0.1167 per share per month, a payment amount it has maintained since its inception. This calculates to an 8.5% annualized yield. A large portion of the distribution comes from ROC, providing you a deferred tax treatment, and bringing advantages to long-term shareholders. Over the past five years, THW’s NAV has increased 3.5% as it paid $ 7 in distributions to shareholders, indicating management is doing an excellent job in preserving the health of the CEF. (Source: THW Annual Report)
THW is an excellent monthly pay CEF from Tekla for income investors, with a healthy balance of domestic and international markets. This CEF is set to be rewarding in the years to come.
Over the years, Berkshire Hathaway (BRK.A) (BRK.B) acquired shares in several leading healthcare companies, however, Mr. Buffett isn’t the only one seduced by the cheap valuations, inflation & recession resilience, and cash flow moats of global pharma and biotech leaders. Realizing that the critical knowledge gap in this subject is crippling their investment efforts, several billionaires are proactively addressing the problem through strategic hiring.
Investing in individual healthcare companies comes with significant risks, including but not limited to drug patent expiration, denied FDA petitions, and failing clinical trials. Getting instant diversity through a CEF helps mitigate these risks while providing you with an excellent income as well.
Through these CEFs, you employ a team of healthcare experts to select and actively manage a portfolio of securities in this lucrative and undervalued sector. With HQH and THW in your portfolio, you don’t have to try to keep up with all the moving pieces of this complicated field. You can sit back and collect your passive income stream, and benefit from the major tailwinds of innovation and growing demand for healthcare from an aging population.