Tekla World Healthcare Fund: High Yield, Monster Expense

ETFS

The art of medicine consists of amusing the patient while nature cures the disease. ― Voltaire

At first glance, Tekla World Healthcare Fund (THW) looks like a solid dividend bet because it has been paying dividends consistently since inception and it sports an attractive dividend yield of 9.57% (as of August 5, 2020). The second big plus is that the fund’s advisors are experts from the medical profession. The third huge advantage is that the healthcare sector stocks are on a roll post-COVID-19, and that kind of rounds up the “love-at-first-sight” feel an investor gets when he first skims through the fund’s basics.

However, there is other stuff lurking beneath the surface that every investor should be aware of.

Before I get to that, here are the fund’s internals:

THW’s Portfolio & Allocation

THW invests in all healthcare subsectors for long-term capital appreciation and income. It is committed to investing at least 40% of its funds in companies outside the U.S. or in companies that earn substantial revenues from markets outside of the U.S. because the fund’s advisors believe that quality global stocks can be available at very attractive prices.

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Image Source: THW Website

About 36% of THW’s funds are invested in 10 holdings, comprising of high-quality stocks like Johnson & Johnson (NYSE:JNJ), Merck (NYSE:MRK), Novartis (NYSE:NVS), Roche (OTCQX:RHHBY), AstraZeneca (NYSE:AZN), among others. About 59% of its total funds are invested in pharmaceutical and biotechnology companies, and about 12% each in healthcare equipment and healthcare providers – these make up 83% of the AUM.

The entire healthcare sector is expected to do very well in the COVID-19 age and thereafter because it is estimated that every country will fortify its healthcare infrastructure to ensure adequate facilities and innovation should any new pandemic or disease occur.

THW’s Dividend History and Momentum

The fund pays $0.1167 as dividend every month ($1.40 annual) and it has not skipped any payout since its inception in 2015.

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Image Source: Seeking Alpha

A $1.40 annual payout works out to a 9.57% yield as of August 5, 2020, and that looks like a solid number when you consider that the fund is advised by experts, owns top-quality stocks, and has not missed a single dividend payout since inception.

THW has moved in a narrow range between $13 and $15 in the last few years. It severely dipped to about $10.50 in March 2020 after the seriousness of the pandemic’s impact was understood – but it recovered back to its narrow range subsequently.

THW’s Fees & Expenses

In its last fiscal that ended on Sep 30, 2019, THW reported a total expense ratio of 2.53%. Advisor Fees were a whopping 1.29%. Here is the impact of these expenses on THW’s 2019 income statement:

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Image Source: Tekla Capital Website

THW earned a total investment income of $12.43 million in fiscal 2019, and it spent $9.3 million on advisory fees and interest expense. After other expenses, the net investment income totaled $1.87 million.

The high expense ratio resulted in THW generating $20.32 million in operating cash flows, paying $45.12 million towards dividend distributions and share purchases. The net result was that THW ended up burning $24.80 million of its cash reserves (p. 23).

Summing Up

THW’s high expense ratio suggests that its portfolio needs a shot of massive momentum every year so that it can easily cover the advisory fees and expenses because dividend income alone is not going to make the cut. Healthcare stocks are in bull territory after COVID-19 and THW may receive that nice booster shot in 2020. The jury is still out for 2021 and beyond.

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Image Source: Twitter

A majority of healthcare industry leaders do not expect the virus to be contained until Q3 2021, so it is likely that the sector will outperform until then.

THW’s dividend commitment works out to about $10.25 million every quarter, but as of September 2019, THW’s cash balances had dwindled to just $5.2 million. It may have borrowed in the first half of 2020 to pay its dividends.

Thus, THW looks like a very solid dividend play at first glance, but its cash flows are facing rough weather. A high expense ratio will keep eating into its balance sheet unless its holdings receive a big dose of momentum almost every year.

THW may work out in the long run, but its medium-term prospects do not look hot. To stay in the game, it needs to pay regular dividends as promised, and if you are a dividend investor who does not care about the high advisory fees and expenses, and shaky cash flows, then you will likely consider THW favorably.

If I were a dividend investor, I would pass up on THW because of the high fees and the cash flow situation. I would rather get into a healthcare ETF that benchmarks an index and maintains a low expense ratio.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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