Dividend Hunter Finds Value at Tekla Life Sciences

11/04/2020 5:00 am EST

Focus: HEALTHCARE

Tim Plaehn

Lead Income Analyst, The Dividend Hunter

Tekla Life Sciences (HQL) is a closed-end fund (CEF) managed by Tekla Capital Management; the fund invests in biotech industry stocks with up to 40% of the portfolio invested in pre-public (“venture”) companies, notes Tim Plaehn, editor of The Dividend Hunter.

The fund's relatively high-yield distribution policy makes the fund interesting. A look at the dividend history shows variable quarterly dividends that give an average yield of about 8%. I would not expect to see dividends paid by the types of companies held in the fund portfolio.

How it works is that Tekla uses a managed distribution policy that lets the fund pay quarterly distributions equal to 2% of the fund’s net asset value (NAV). Two percent times four quarters add up to an 8% distribution yield. As the website explains:

Of the last 26 distributions, paid since September 2014, 18 were classified as capital gains, and the remaining eight were a combination of capital gains and return of capital. To be realized capital gains, fund investment had to have been sold, and profits realized.

For a fund that does not earn portfolio income or sell options for extra income, I think that producing over 70% realized capital gains to support an 8% distribution rate is a pretty good track record.

HQL offers an interesting and, I believe, unique way to get biotech investment exposure. The distribution policy provides cash back to use for other purposes, and I think it makes the managers stay focused on generating profits.

Historical returns are as bumpy as you might expect from a biotech focused fund. Here are the historical annualized returns:

tdhi

The ten-year chart shows the large swings experienced by the biotech sector. You can see the significant drop that occurred in 2015. I am not sure of the cause, but that is close to a 50% decline, which only recently showed a full share price recovery. But remember, HQL also paid a sizable quarterly distribution along the way.

hql

Finally, CEFs can trade at a discount or premium to NAV. For the past couple of years, the discount for HQL has stayed close to 10%. It currently shows a 12.8% discount to NAV.

During the early 2020 stock market crash, the discount widened out to 22%. With this fund, buying assets at a discount should be viewed as a benefit.

Overall, Tekla Life Sciences Investors offers an attractive, distribution paying way to get investment exposure to the biotech sector. It a world following the coronavirus pandemic, biotech should draw more investor interest; there is potential for this fund to generate longer-term returns like you see in the ten-year track record.

But if you do invest, note: Tekla Life Sciences is not an investment that can be viewed as a stable high-yield dividend payer, where you are counting on the dividend payments.

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