Biotech with a Venture Capital Twist

09/27/2013 7:00 am EST

Focus: ETFs

Our latest featured recommendation is a closed-end fund that specializes in the biotechnology sector; it offers the potential for long-term growth with a substantial income kicker, suggests Art Charney, editor of Big Yield Hunting.

H&Q Life Sciences (HQL) is very different from the average healthcare fund. First, it largely specializes in the biotechnology sector, so its investments are generally riskier than some of the more traditional healthcare stocks.

Biotech stocks, including well-known names such as Gilead Sciences (GILD) and Celgene (CELG), were nearly 60% of assets.

Almost a third of the fund's equity sleeve was allocated toward small- and mid-cap stocks. And the fund also had a substantial 12.7% allocation to micro-cap stocks. And the fund bets heavily on its favorites, with 48.3% of assets in its top ten holdings.

And because it's a closed-end fund, HQL has fewer constraints on its investments than a traditional mutual fund. For instance, HQL is permitted to invest up to 40% of its assets in venture or restricted securities.

In other words, the fund not only invests in cutting-edge stocks, it also has a venture-capital sleeve that offers exposure to firms that may not even be public yet.

Fortunately, management knows how to navigate this risky space. The two principal portfolio managers both have PhDs and extensive industry experience.

Lead manager Daniel Omstead was previously president and CEO of a development-stage biotech company that specialized in regenerative medicine, and prior to that, spent 14 years in the pharmaceutical industry.

And Frank Gentile worked in both the pharmaceutical and biotech industries and holds 30 US patents in the biotech realm. Both have been with the fund for well-over a decade and work alongside two other analysts with similar backgrounds and longevity with the fund.

This rare combination of experience and financial acumen has translated into an impressive performance in recent years, with the portfolio gaining 32.6% over the past three years.

HQL has a managed distribution policy under which it makes a quarterly payout that's equivalent to 2% of net assets.

The distribution can consist of short- or long-term capital gains, dividends from equity investments, interest from fixed-income investments, and occasionally the dreaded return of capital. So the tax consequences of the fund's distributions will vary over time.

HQL currently trades at nearly a 4% discount to NAV, so we're setting our buy target based upon a 3% discount to the fund's NAV on September 19, which was $20.38. Buy HQL below $19.77.

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