THW: Bet On Healthcare With This 10.88%-Yielding CEF – Tekla World Healthcare Fund (NYSE:THW)

A few days ago, I published an article to this site discussing one of the better biotechnology funds, which is an area of the economy that could quite easily have a very bright future. However, the entire healthcare industry itself is likely to prove quite promising due to certain conditions becoming more prevalent as well as demographic shifts that are pushing a greater proportion of the population into age brackets in which they are likely to require the services of the healthcare industry. I have in the past discussed one of the ways that I am playing these trends, the Tekla World Healthcare Fund (THW), but that was several months ago. Therefore, I feel that the time is appropriate to discuss some of the changes that the fund has made so that we can remain aware of exactly where our money is invested.

About The Fund

According to the fund’s web page, the Tekla World Healthcare Fund has the objective of seeking current income and long-term capital appreciation by investing in both equity and debt securities of companies in the healthcare industry. This differs somewhat from Tekla Life Sciences Investors (HQL), the aforementioned biotechnology fund, in that the latter fund is solely interested in generating capital appreciation. Most closed-end funds do focus both on the generation of capital gains and current income, though, so THW is far from unique in this case.

As the name implies, the Tekla World Healthcare Fund invests in companies from all around the world and does not exclusively focus on just one region. We can see this quite clearly just from looking at the fund’s top ten holdings:

Source: Tekla Capital Management

Clearly, there are companies here that are based in various countries, although nearly all of them are based in the United States or Western Europe. This is something that I generally do like to see as it allows for the spreading of risk and allows the fund to diversify away from risks that are unique to the United States or any other country. A perfect example here is that a company like UnitedHealth Group (UNH) will be a lot more affected by changes in the Affordable Care Act or the implementation of a single-payer system in the United States than a company like Novartis (NVS) or Bayer AG (OTCPK:BAYRY) would be.

As my regular readers on closed-end funds are no doubt well aware, I generally dislike seeing any particular holding in a fund have a weighting above 5% of total assets. This is because 5% is approximately the level at which an asset begins to expose the fund as a whole to idiosyncratic risk. Idiosyncratic, or company-specific, risk is the risk that any financial asset has that is independent of the market as a whole. The risk here is that if some event happens that causes the stock price of a given heavily-weighted asset to decline, then it will have a very noticeable downward impact on the fund’s net asset value. As we can see above, only Johnson & Johnson (JNJ) and Novartis have a weighting above 5% and fortunately neither one is particularly much above it. In addition, due to the relatively inelastic nature of their industry, healthcare companies are generally more stable than companies in other industries. Thus, for the most part, the fund appears to be fairly well diversified.

In my last article on THW, I noted that the fund had only a very small amount of exposure to Johnson & Johnson. This was in stark contrast to most healthcare funds that hold the pharmaceutical and medical supplies giant as their largest position and helped protect the fund’s value when the stock plunged last year following the $4.7 billion settlement against the company due to the alleged presence of asbestos in baby powder. As we can clearly see above, though, the fund has increased its position in Johnson & Johnson since that time, likely to capitalize on an expectation of capital gains following the event. However, this expectation has largely not materialized as Johnson & Johnson is only up 5.37% since the beginning of the year, which is not particularly impressive. This has almost certainly dragged on the fund’s performance this year.

One thing that we also see here is that the fund has been maintaining an outsized exposure to pharmaceuticals, although this exposure has been moderating over the past year or so:

THW: Bet On Healthcare With This 10.88%-Yielding CEF - Tekla World Healthcare Fund (NYSE:THW)Source: Tekla Capital Management

Pharmaceuticals as a whole is one sector of the healthcare industry that has attracted a great deal of political scrutiny in the United States recently. Although I have not heard much about it in the news lately, politicians on both sides of the aisle have been calling for the government to do something about drug prices. As such an action would certainly have a sharply negative impact on the profitability of the companies in this industry segment, it does make a lot of sense that the fund would want to reduce its exposure. It is also nice to see that the fund is more diversified than it was when I first started following it in the middle of last year.

Why Invest In Healthcare?

At this point, the reader might be wondering why they should invest in healthcare. As I pointed out in the introduction, there are a few good reasons to include healthcare in your portfolio. One of the most important of these is that the population of the United States is aging quickly, as is the case in most other developed nations.

According to the US Census Bureau, there are approximately 72 to 74 million Americans aged 54 to 73 years old. This is what is known as the Baby Boomer generation as they were born to returning American soldiers in the relatively prosperous period following the end of the Second World War. This generation represents approximately 20% of the American population and it is larger than any generation that came before it. This point is very important because it means that the number of people in the twilight years of their lives is poised to surge in the coming years. As a general rule, once an individual passes eighty years of age, their health begins to deteriorate and their consumption of healthcare goods and services increases dramatically. As the members of the Baby Boomer generation will all reach this point over the next 25 years, we can conclude that spending on the products provided by healthcare companies will climb.

A second trend that is likely to stimulate growth in the healthcare sector is the rising obesity rate. Currently, the obesity rate in the United States is about 39%, but current projections point to it increasing to 55% by 2045. There are several health problems that accompany obesity, including high blood pressure, diabetes, hypertension, heart disease, and osteoarthritis, among others. Naturally, as these conditions become more common due to a growing obesity rate, there will be higher demand to treat them. This can be expected to result in climbing revenues for the companies in the healthcare industry as they move to treat these conditions.

Overall then, the future looks rather bright for the healthcare industry and investors would be wise to have some exposure to it.

Distributions

Closed-end funds are fairly well known for the relatively high distribution yields that they pay out. This is mostly due to the funds paying out any dividends that they receive or capital gains that they generate to their shareholders. This both helps the fund meet its goal of providing income to its shareholders as well as keeping the share price at a reasonable level for the retail investors that normally invest in such funds. Thus, we might expect THW to pay out a relatively high yield to its shareholders. This is indeed the case as the fund pays out a distribution of $0.1167 per month per share ($1.40 per share annualized), which gives the fund a 10.88% yield at the current distribution rate.

Valuation

As is always the case, it is critical for us to ensure that we do not overpay for any asset in our portfolio. This is because overpaying for any asset is a surefire way to ensure sub-optimal returns from that asset. In the case of a closed-end fund like THW, the usual way to value it is by using net asset value, which is the current market value of all of the assets in the fund’s portfolio minus any outstanding debt. It is therefore the amount of money that the shareholders would receive if all of the fund’s assets were sold off and the fund were liquidated.

Ideally, we want to buy shares of the fund at a price below the net asset value per share. This is because such a situation essentially means that we are getting the assets of the fund for less than they are actually worth. This is the case currently as the fund has a net asset value of $13.78 per share as of April 11, 2019 (the latest date for which data is currently available), but trades for a price of $12.87 per share. This gives the fund a 6.60% discount to net asset value as of the time of writing and represents an attractive entry price.

Conclusion

In conclusion, it is likely a good idea to have some exposure to the healthcare industry due to the impact that the changing developed world demographics are likely to have on the industry. The Tekla World Healthcare Fund is a good way to gain this exposure due to its diversification and high yield. The fund is currently trading at an appealing entry price so it may be worth considering here.

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Disclosure: I am/we are long THW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.